Edited version of private advice

Authorisation Number: 1012023275349

Date of advice: 10 February 2011

Ruling

Subject: Off-market share buy back

Question 1

Will the portion of the Buy-back Price exceeding the Capital Component which is debited to A Co's share capital account be a dividend for the purposes of section 159GZZZP of the Income Tax Assessment Act 1936 (ITAA 1936) and a frankable distribution for the purposes of section 202-40 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes

Question 2

Will the Commissioner make a determination under subsections 45B(3) and 45C(3) of the ITAA 1936, that a franking debit applies to the Capital Component of the Buy-back?

Answer

No

Question 3

Will the Commissioner make a determination under paragraph 204-30(3)(a) of the ITAA 1997 to debit A Co's franking account?

Answer

No

Question 4

Will the Commissioner make a determination under paragraph 177EA(5)(a) of the ITAA 1936 to debit A Co's franking account?

Answer

No

Relevant facts and circumstances

Background

A Co is a private, unlisted company incorporated in Australia and is the head of an Australian consolidated group.

All the company's shares are of one class.

Shareholders include Australian resident individuals, companies, trust estates, superannuation funds and charities.

A Co pays fully franked dividends twice a year.

A Co has a dividend reinvestment plan in place.

A Co's share capital account is not tainted for the purposes of Division 197 of the ITAA 1997.

Scheme

The Board of A Co will invite shareholders to offer some or all of their shares to the company by choosing a nominated discount percentage from the market value of the shares.

Shareholders may choose to offer their shares as a "final price tender", meaning that they agree to accept whatever discount is arrived at following the nominated percentages of other shareholders' tenders.

The tender process will remain open for a period of 21 days and offers may be tendered at any time within that period. However, A Co will make no decision to accept any offer until the 21 day period has expired, and the extent of its acceptances, if any, will depend upon the terms of the offers tendered.

Shareholders who tender their shares at a discount which is smaller than that accepted by the Board will have none of those shares bought back. Shareholders who tender their shares at a discount which is greater than that accepted by the Board will benefit from selling at a lower-than-tendered discount.

If necessary, as a result of tenders exceeding a pre-determined amount of aggregate buy-back consideration, an equitable scale-back will be applied, proportionate to the number of shares tendered by each participating shareholder.

The Buy-back Price will be debited to A Co's share capital account proportionately to the available share capital per share. The balance of the Buy-back price will be debited against retained profits.

The bought back shares will be cancelled by A Co, and the cash consideration will be remitted to shareholders.

Relevant legislative provisions

Income Tax Assessment Act 1936 Section 45B,

Income Tax Assessment Act 1936 Subsection 45B(3),

Income Tax Assessment Act 1936 Subsection 45B(8),

Income Tax Assessment Act 1936 Section 45C,

Income Tax Assessment Act 1936 Subsection 45C(3),

Income Tax Assessment Act 1936 Section 159GZZZP,

Income Tax Assessment Act 1997 Section 202-40,

Income Tax Assessment Act 1997 Section 202-45,

Income Tax Assessment Act 1997 Section 202-45(c),

Income Tax Assessment Act 1997 Section 204-30,

Income Tax Assessment Act 1997 Paragraph 204-30(a),

Income Tax Assessment Act 1997 Paragraph 204-30(1)(a),

Income Tax Assessment Act 1997 Paragraph 204-30(1)(b),

Income Tax Assessment Act 1997 Paragraph 204-30(1)(c),

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

Income Tax Assessment Act 1997 Paragraph 204-30(3)(a),

Income Tax Assessment Act 1997 Paragraph 204-30(3)(c),

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

Income Tax Assessment Act 1997 Subsection 177EA(3),

Income Tax Assessment Act 1997 Paragraph 177EA(3)(a),

Income Tax Assessment Act 1997 Paragraph 177EA(3)(b)(i),

Income Tax Assessment Act 1997 Paragraph 177EA(3)(c),

Income Tax Assessment Act 1997 Paragraph 177EA(3)(d),

Income Tax Assessment Act 1997 Paragraph 177EA(5)(a),

Income Tax Assessment Act 1997 Paragraph 177EA(14)(b),

Income Tax Assessment Act 1997 Paragraph 177EA(17)(b),

Income Tax Assessment Act 1997 Paragraph 177EA(17)(c),

Income Tax Assessment Act 1997 Paragraph 177EA(17)(g),

Income Tax Assessment Act 1997 Paragraph 177EA(17)(j).

Reasons for decision

Question 1

Will the portion of the Buy-back Price exceeding the Capital Component which is debited to A Co's share capital account be a dividend for the purposes of section 159GZZZP of the Income Tax Assessment Act 1936 (ITAA 1936) and a frankable distribution for the purposes of section 202-40 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Detailed reasoning

Section 159GZZZP of the ITAA 1936 provides that where the buy-back of a share is an off-market purchase, the difference between the purchase price and the part (if any) of the purchase price which is debited against the share capital account, is taken to be a dividend paid by the company to the seller on the day the buy-back occurs.

The Dividend Component is frankable but only to the extent that the Buy-back Price does not exceed 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 (paragraph 202-45(c) of the ITAA 1997).

The Buy-back offer price (purchase price) will be determined after the tender process period has expired and will be less or equal to the market value per share which has been established for the purposes of this share Buy-back.

The amount representing the portion of the Buy-back Price exceeding the Capital Component which is debited to A Co's share capital account is a dividend for the purposes of section 159GZZZP of the ITAA 1936. This amount is a frankable distribution for the purposes of section 202-40 of the ITAA 1997. As the Buy-back Price will not exceed what would be 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, paragraph 202-45(c) of the ITAA 1997 does not apply.

Question 2

Will the Commissioner make a determination under subsections 45B(3) and 45C(3) of the ITAA 1936, that a franking debit applies to the Capital Component of the Buy-back?

Detailed reasoning

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 there is no requisite purpose, by way of capital distribution, of enabling the shareholders to obtain a tax benefit. Further, the Capital Component of the Buy-back cannot be said to be attributable to the profits of A Co. Therefore, the Commissioner will not make a determination under section 45B of the ITAA 1936 that section 45C applies to the whole, or any part of the Capital Component of the Buy-back Price.

Question 3

Will the Commissioner make a determination under paragraph 204-30(3)(a) of the ITAA 1997 to debit A Co's franking account?

Detailed reasoning

Section 204-30 of the ITAA 1997 applies where a corporate tax entity streams the payment of dividends, or the payment of dividends and the giving of other benefits, to its members in such a way that:

a)    an imputation benefit is, or apart from this section would be, received by a member of the entity as a result of the distribution or distributions (paragraph 204-30(1)(a)); and

b)    the member would derive a greater benefit from franking credits than another member of the entity (paragraph 204-30(1)(b)); and

c)    the other member of the entity will receive lesser imputation benefits, or will not receive any imputation benefits, whether or not the other member receives other benefits (paragraph 204-30(1)(c)).

Relevantly, if section 204-30 of the ITAA 1997 applies the Commissioner is vested with discretion under subsection 204-30(3) to make a determination in writing either:

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

b)    ...

c)    that no imputation benefit is to arise in respect of any streamed distributions made to a favoured member and specified in the determination (paragraph 204-30(3)(c)).

For section 204-30 of the ITAA 1997 to apply, 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) of the ITAA 1997 by reference to the ability of the members to fully utilise imputation benefits.

Having had regard to the structure of the A Co Buy-back, the Commissioner is of the opinion that members that participate in the Buy-back will not derive a greater benefit from imputation benefits than the members who do not participate in the Buy-back. Therefore, the Commissioner will not make a determination under section 204-30 of the ITAA 1997 to debit A Co's franking account as a result of the Buy-back.

Question 4

Will the Commissioner make a determination under paragraph 177EA(5)(a) of the ITAA 1936 to debit A Co's franking account?

Detailed reasoning

Section 177EA of the ITAA 1936 is a general anti-avoidance rule intended to apply to schemes to obtain a tax advantage in relation to imputation benefits.

The operative provision of section 177EA of the ITAA 1936 is subsection 177EA(3) of the ITAA 1936. This provision 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.

Pursuant to paragraph 177EA(14)(b) of the ITAA 1936, the meaning of "scheme for a disposition of membership interests or an interest in membership interests" includes a scheme that involves the entering into any contract or transaction or dealing that changes or otherwise affects the legal or equitable ownership of membership interests or an interest in membership interests.

A buy-back of shares would constitute a scheme for a disposition of membership interests and paragraph 177EA(3)(a) of the ITAA 1936 is satisfied.

The A Co Buy-back will result in the payment of a frankable distribution and the distribution is expected to be franked. Accordingly, subparagraph 177EA(3)(b)(i) and paragraph 177EA(3)(c) of the ITAA 1936 are satisfied.

Paragraph 177EA(3)(d) of the ITAA 1936 is met as A Co shareholders would receive, or be reasonably expected to receive, imputation benefits as a result of the distribution.

Accordingly, the issue is whether, having regard to the relevant circumstances of the scheme, it would be concluded that, on the part of A Co, the shareholders or any other relevant party, there is a purpose more than merely an incidental purpose of conferring an imputation benefit under the scheme. Circumstances which are relevant in determining whether any person has the requisite purpose include, but are not limited to, the factors listed in subsection 177EA(17) of the ITAA 1936.

In this regard, the Commissioner is of the view that the structure of the A Co Buy-back reflects a purpose, which is more than incidental, of enabling the participating shareholders to obtain an imputation benefit. In coming to this conclusion the Commissioner had regard to all the relevant circumstances of the arrangement, including those covered by paragraphs 177EA(17)(b), (c), (g) and (j) of the ITAA 1936, with particular weight attributed to paragraph 177EA(17)(b).

However, given that the quantum of any debit is a result of a negligible non-resident population, the Commissioner will exercise his discretion in such a way that no debit will be made to the franking credit account of A Co.