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Ruling

Subject: Off Market Share Buy-Back

Question 1

Will the portion of the Buy-Back Price exceeding the capital component be a dividend for the purposes of section 159GZZZP of the Income Tax Assessment Act 1936 (ITAA 1936)?

Answer

Yes

Question 2

Will that same portion be a frankable distribution for the purposes of section 202-40 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

No

Question 3

Will either the:

o Non Resident Beneficiary; or

o Resident Trust

o receive an imputation benefit under the proposed buy-back as required by subsection 177EA(3)(d) of the ITAA 1936?

Answer

No

Yes

Question 4

Having regard to the relevant circumstances of the buy-back, could it be concluded that any of the taxpayers involved entered into the proposed buy-back for a purpose of obtaining an imputation benefit, as required by subsection 177EA(3)(e) of the ITAA 1936?

Answer

No

Question 5

In light of the answers to questions 3 and 4, will the Commissioner make a determination under subsection 177EA(5) of the ITAA 1936 to:

· treat the franked dividend component of the Buy-Back Price as an unfranked dividend; or

· to debit the franking account of Company A to the extent to which imputation credits were allocated to the dividend component of the Buy-Back Price?

Answer

No

This ruling applies for the following periods:

1 July 2011 to 30 June 2013

The scheme commences on:

Not yet commenced

Relevant facts and circumstances

Resident Trust currently holds a parcel of shares in Company A. Company A has proposed to undertake a selective off-market share buy-back of all of Resident Trust's shares.

The beneficiaries of Resident Trust include Non Resident Beneficiary and immediate family. The proceeds Resident Trust receives from the buy-back will be distributed solely to Non Resident Beneficiary.

In consideration for its shares, Resident Trust will receive an amount referred to as the Buy-Back Price.

A portion of the buy back price, equal to the cost base of the shares, will be debited against Company A's share capital account.

The balance will be debited against Company A's retained earnings account.

Relevant legislative provisions

Income Tax Assessment Act 1936 Subsection 98(3)

Income Tax Assessment Act 1936 Subsection 98A(2)(b)

Income Tax Assessment Act 1936 Section 128B

Income Tax Assessment Act 1936 Paragraph 128B(3)(ga)

Income Tax Assessment Act 1936 Subsection 159GZZZP(1)

Income Tax Assessment Act 1936 Section 177EA

Income Tax Assessment Act 1936 Subsection 177EA(3)

Income Tax Assessment Act 1936 Paragraph 177EA(3)(a)

Income Tax Assessment Act 1936 Paragraph 177EA(3)(b)

Income Tax Assessment Act 1936 Paragraph 177EA(3)(c)

Income Tax Assessment Act 1936 Paragraph 177EA(3)(d)

Income Tax Assessment Act 1936 Paragraph 177EA(3)(e)

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(13)

Income Tax Assessment Act 1936 Paragraph 177EA(13)(c)

Income Tax Assessment Act 1936 Subsection 177EA(14)

Income Tax Assessment Act 1936 Paragraph 177EA(14)(a)

Income Tax Assessment Act 1936 Paragraph 177EA(14)(b)

Income Tax Assessment Act 1936 Paragraph 177EA(14)(d)

Income Tax Assessment Act 1936 Subsection 177EA(16)

Income Tax Assessment Act 1936 Paragraph 177EA(16)(b)

Income Tax Assessment Act 1936 Subsection 177EA(17)

Income Tax Assessment Act 1936 Subsection 177EA(19)

Income Tax Assessment Act 1997 Section 202-5

Income Tax Assessment Act 1997 Section 202-40

Income Tax Assessment Act 1997 Subsection 202-40(1)

Income Tax Assessment Act 1997 Paragraph 202-45(c)

Income Tax Assessment Act 1997 Paragraph 202-45(e)

Income Tax Assessment Act 1997 Paragraph 204-30(6)(b)

Income Tax Assessment Act 1997 Section 207-50

Income Tax Assessment Act 1997 Section 995-1

Reasons for decision

Question 1

Summary

The portion of the Buy-Back Price exceeding the capital component will be a dividend for the purposes of section 159GZZZP of the ITAA 1936.

Detailed reasoning

Subsection 159GZZZP(1) of the ITAA 1936 provides that where the buy-back of a share is an off-market purchase, the difference between the buy-back purchase price and the part of the buy-back purchase price which is debited against amounts standing to the credit of the company's share capital account is taken to be a dividend paid by the company, to the seller as a shareholder in the company, out of profits derived by the company, and on the day the buy-back occurs.

Question 2

Summary

The portion of the Buy-Back Price exceeding the capital component will not all be a frankable distribution for the purposes of section 202-40 of the ITAA 1997.

Detailed reasoning

The dividend component will be a distribution pursuant to subsection 960-120(1) of the ITAA 1997. Pursuant to subsection 202-40(1) of the ITAA 1997, a distribution is a frankable distribution to the extent that it is not unfrankable under section 202-45 of the ITAA 1997.

Section 202-45 of the ITAA 1997 lists those distributions that are unfrankable. Paragraph 202-45(c) of the ITAA 1997 provides that so much of the buy-back purchase price that exceeds the market value of the share at the time of the buy-back (if the buy-back did not occur or was never proposed to occur) is an unfrankable distribution. If the buy-back purchase price exceeds the market value, the excess cannot be a frankable distribution in accordance with section 202-40 of the ITAA 1997.

A portion of the dividend component will be a frankable distribution, to the extent the purchase price per share does not exceed the market value of the share (paragraph 202-45(c) of the ITAA 1997).

A portion of the dividend component will be an unfrankable distribution, to the extent the purchase price per share exceeds the market value of the share (paragraph 202-45(c) of the ITAA 1997).

Further, the capital component is not frankable according to subsection 202-45(e).

Question 3

Summary

(a) Non Resident Beneficiary will not receive an imputation benefit under the proposed buy-back as required by subsection 177EA(3)(d) of the ITAA 1936.

(b) Resident Trust will receive an imputation benefit under the proposed buy back pursuant to section 204-30(6)(b). However, the requirements of subsection 177EA(3)(d) of the ITAA 1936 are not satisfied as Resident Trust are not the relevant taxpayer in this regard.

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 franking credits or tax offsets. In essence, it applies to schemes for the disposition of shares, or an interest in shares where a franked dividend is paid or payable in respect of the shares. This would include a buy-back with a frankable distribution (franked distribution) component.

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

· either:

· 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; and

· the distribution was, or is expected to be, a franked distribution or a distribution franked with an exempting credit; and

· 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

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.

Non Resident Beneficiary

In the present case the conditions of paragraphs 177EA(3)(a) to 177EA(3)(c) of the ITAA 1936 are satisfied.

Paragraph 177EA(3)(d) of the ITAA 1936 requires that the person would receive or could reasonably be expected to receive, imputation benefits as a result of the distribution. The person is referred to as the relevant taxpayer, and has the meaning given by subsection (3).

The relevant taxpayer for the purposes of this element is the person who receives the franked distribution, or part of the franked distribution.

The distribution will initially be received by the trustee of Resident Trust. However, it will not retain the benefit of the distribution, but will apply it for the benefit of Non Resident Beneficiary.

It follows that it is Non Resident Beneficiary as the ultimate recipient who stands to receive the distribution. As a result it is Non Resident Beneficiary that is the relevant taxpayer.

Under subsection 177EA(16) a taxpayer receives an imputation benefit as a result of a distribution if:

(a) the taxpayer is entitled to a tax offset under Division 207 as a result of the distribution, or

(b) the taxpayer is a corporate tax entity - a franking credit would arise in its franking account as a result of the distribution.

The franked distribution may flow indirectly to a beneficiary of certain trusts (Section 207-50 of the ITAA 1997).

Pursuant to subsection 177EA(16)(a) where a taxpayer receives a distribution indirectly, they are taken to have received an imputation benefit for the purpose of subsection 177EA(3)(d) if they are entitled to a tax offset under Division 207 of the ITAA 1997. Non-residents are not entitled to any such offset. Therefore 177EA(16)(a) does not apply given the relevant taxpayer is a non-resident.

Furthermore, paragraph 177EA(16)(b) does not apply as the relevant taxpayer is not a corporate tax entity.

Given the above, paragraph 177EA(3)(d) is not satisfied because the relevant taxpayer does not receive an imputation benefit.

Resident Trust

The provisions relating to the taxation of trust income are contained in Part III Division 6 (sections 95 to 102 of the ITAA 1936).

Where a beneficiary is presently entitled to a share of trust income, and is a non-resident at the end of the year of income, the trustee is primarily liable to pay tax in respect of that share.

Section 98(3) applies to assess the trustee if the beneficiary is:

(1) a non-resident at the end of the income year;

(2) presently entitled to all or part of the income of a trust estate during the income year (but not deemed to be presently entitled by virtue of s 95A(2)); and

(3) not under a legal disability.

The trustee is assessed on the corresponding share of the net income of the trust estate, excluding any income from non-Australian sources derived by the trustee during the beneficiary's period of non-residence.

The income assessed to the trustee is also assessed to the beneficiary under s 98A and a credit allowed for tax paid by the trustee (but not to the extent allowed under s 98B). If the tax paid by the trustee exceeds the amount payable by the beneficiary, the difference is payable by the Commissioner to the beneficiary (s 98A(2)(b)).

The ATO has determined the dividend component of the buy-back price comprises both a frankable and unfrankable component. Given section 98(3) applies to assess the trustee on the net income of the trust estate, it must then be considered whether an imputation benefit is received by Resident Trust pursuant to section 204-30(6)(a) ITAA 1997.

Section 204-30(6)(a) provides that a member of an entity receives an imputation benefit as a result of a distribution if the member is entitled to a tax offset under Division 207 as a result of the distribution.

Section 204-30(6)(b) provides that a member of an entity receives an imputation benefit as a result of a distribution if an amount would be included in the member's assessable income as a result of the distribution because of the operation of section 207-35 ITAA 1997.

Pursuant to subsection 207-35(1) of the ITAA 1997, Resident Trust will include in its assessable income the amount of the franking credit on the frankable component of the buy back price.

As such, the requirements of section 204-30(6)(b) are satisfied and Resident Trust will receive an imputation benefit.

However, this has no bearing on the application of subsection 177EA(3)(d). As concluded above the relevant taxpayer for the purposes of this element is the person who receives the franked distribution, or part of the franked distribution, being Non Resident Beneficiary.

It follows that it is Non Resident Beneficiary as the ultimate recipient who stands to receive the distribution. As a result it is Non Resident Beneficiary that is the relevant taxpayer and as such must receive an imputation benefit to satisfy the requirements of section 177EA(3)(d).

To the extent the frankable component of the distribution is fully franked, Non Resident Beneficiary will not be liable for Australian withholding tax under paragraph 128B(3)(ga) of the ITAA 1936.

A liability to Australian withholding tax will arise with respect to the unfrankable component of the distribution pursuant to section 128B ITAA 1936.

Question 4

Having regard to the relevant circumstances of the buy-back, it could not be concluded that any of the taxpayers involved entered into the proposed buy-back for a purpose of obtaining an imputation benefit, as required by subsection 177EA(3)(e) of the ITAA 1936.

Given the fourth element of subsection 177EA(3) of the ITAA 1936 is not satisfied, the Commissioner has come to the view that section 177EA does not apply to the Buy Back.

Question 5

In light of the answers to questions 3 and 4, the Commissioner will not make a determination under subsection 177EA(5) of the ITAA 1936 to:

· treat the franked dividend component of the Buy-Back Price as an unfranked dividend; or

· to debit the franking account of Company A to the extent to which imputation credits were allocated to the dividend component of the Buy-Back Price.