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Ruling

Subject: Share Buy-Back Arrangement

Question 1

Will the buy-back of shares by the Australian Resident Company (the Company) result in the Taxpayer being deemed to have received a dividend pursuant to section 159GZZZP of the Income Tax Assessment Act 1936 (ITAA 1936)?

Answer

No.

Question 2

Will the buy-back of shares by the Company result in the Taxpayer being deemed to have derived a capital gain under the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

No.

Question 3

Are there any capital gains tax (CGT) consequences for the Company, the Taxpayer or the Company's shareholders in cancelling the shares under the ITAA 1997?

Answer

No.

Question 4

Will there be a trust estate over the Company's shares for the purposes of the ITAA 1936 or the ITAA 1997 if the Australian Securities and Investment Commission (ASIC) and the Australian Taxation Office (the ATO) issue favourable rulings sought, including this ruling?

Answer

Yes.

Question 5

If there is a trust estate over the Company's shares for the purposes of the ITAA 1936 or the ITAA 1997 if ASIC and the ATO issues favourable rulings sought, will the creation of interests or the passing of interests in the trust assets result in a tax liability?

Answer

No.

Question 6

Will Part IVA of the ITAA 1936 apply as a result of the proposed transactions?

Answer

No.

This ruling applies for the following period:

Year ending 30 June 2013

Relevant facts and circumstances

The Company and the Taxpayer

The Company is an unlisted company.

The Company is an Australian resident as defined under subsection 6(1) of the ITAA 1936.

The Company operates in a trading market and develops hardware and software solutions for this purpose.

The Taxpayer is an unlisted company, wholly owned by the Company.

The Taxpayer is an Australian resident as defined under subsection 6(1) of the ITAA 1936.

The Company and the Taxpayer will be part of the same consolidated group as defined in Division 703 of the ITAA 1997. The Company chose to consolidate from 1 July 2011 pursuant to section 703-50 of the ITAA 1997.

The Company shares held on trust

If ASIC grants the exemption and the ATO provides a favourable ruling, the Taxpayer is deemed to have held the Company shares at all times on bare trust for the Company on the basis that they are cancelled in accordance with the Corporations Act.

The shares will be cancelled forthwith and the bare trust will cease to exist and no income will be derived by the trust during its existence. It is proposed that the Company will cancel the shares held by the Taxpayer for amounts equal to the amounts paid for them by the Taxpayer.

The transfer of the shares in a parent company (i.e. the Company) to a subsidiary (i.e. the Taxpayer) is void pursuant to section 259C of the Corporations Act unless ASIC provides an exemption.

The Taxpayer has applied to ASIC for an exemption under section 259C of the Corporation Act, enabling it to hold the shares on trust for the Company on the condition that the shares are cancelled forthwith.

Assumption

ASIC will grant the exemption under subsection 259C of the Corporations Act.

Relevant legislative provisions

Income Tax Assessment Act 1936 Subsection 6(1)

Income Tax Assessment Act 1936 Section 97

Income Tax Assessment Act 1936 Section 159GZZZK

Income Tax Assessment Act 1936 Section 159GZZZN

Income Tax Assessment Act 1936 Section 159GZZZP

Income Tax Assessment Act 1936 Section 177A

Income Tax Assessment Act 1936 Section 177C

Income Tax Assessment Act 1936 Section 177D

Income Tax Assessment Act 1936 Section 177F

Income Tax Assessment Act 1997 Section 104-25

Income Tax Assessment Act 1997 Section 701-1

Income Tax Assessment Act 1997 Section 703-50

Reasons for decision

Question 1

Summary

As the Taxpayer originally acquired the Company shares from the Employee Entities on bare trust for the Company, the application of the share buy-back provisions in Division 16K of Part III of the ITAA 1936 do not apply to the Taxpayer to determine whether the Taxpayer has a deemed dividend in respect of the buy-back of the Company shares.

Detailed reasoning

Section 159GZZZK of the ITAA 1936 provides that where a company buys a share in itself from a shareholder in the company:

· the purchase is a buy-back; and

· the shareholder is a seller; and

· 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; and

if the buy-back is not covered by paragraph (c) - the buy-back is an off-market purchase.

Accordingly, any purchase by the Company of shares in itself from any of its shareholders will be an off-market buy-back as none its shares are listed on any official stock exchange. As a shareholder, the Taxpayer is the prima facie seller when it sells its shares in the Company back to the Company.

However, the Taxpayer originally purchased its shares in the Company from the Employee Entities on bare trust for the Company. Based on the terms of the bare trust, the Company has an absolute, indefeasible entitlement to the capital and the income of the trust and the bare trust is therefore a Transparent Trust: Law Administration Practice Statement PS LA 2000/2: An exemption for the trustees of some trust estates from the requirement to furnish a tax return on behalf of the trust estate (PS LA 2000/2).

As a Transparent Trust, the provisions of the ITAA 1936 and ITAA 1997 will apply to the beneficiary, and not the trustee, in respect of the income of the trust because the beneficiary has an absolute entitlement to the income of the trust and an absolute entitlement to the trust property: PS LA 2000/2 at paragraphs 10 and 11. Accordingly, the Taxpayer is effectively 'ignored' for the purposes of applying the tax provisions in respect of the purchase of the Company shares from the Employee Entities because the shares have been purchased by the Taxpayer on bare trust for the Company.

Instead, the provisions of the ITAA 1936 and ITAA 1997 are applied to the Company as though the Company has purchased the shares directly from the Employee Entities. As such, the purchase of the Company shares from the Employee Entities by the Taxpayer on bare trust for the Company is an off-market buy-back according to the definition in section 159GZZZK of the ITAA 1936.

By operation of section 159GZZZN of the ITAA 1936, however, if a company buys-back a share, the buy-back and any subsequent cancellation of the share are disregarded for the purposes of determining the company's assessable income, allowable deductions or whether it makes a capital gain or capital loss. Accordingly, the buy-back of the Company shares by the Company through the Taxpayer on bare trust is disregarded for the purposes of determining the Company's taxable income.

For completeness, the share buy-back provisions of the ITAA 1936 and ITAA 1997 do not apply when legal title of the Company shares is transferred from the Taxpayer to the Company because the provisions have already been applied when the Taxpayer acquired the shares from the Employee Entities on bare trust for the Company. Accordingly, the Taxpayer will not be deemed to have received a dividend pursuant to section 159GZZZP of the ITAA 1936.

It is also noted that the Company and the Taxpayer are part of a consolidated group as defined in Division 703 of the ITAA 1997. Accordingly, by operation of subsection 701-1(1) of the ITAA 1997, the Taxpayer is taken to be part of the Company, as the head company of the group. Intra-group asset transfers, debt and shareholding are ignored for income tax purposes.

Question 2

Summary

As the Taxpayer originally acquired the Company shares from the Employee Entities on bare trust for the Company, the application of the share buy-back provisions in Division 16K of Part III of the ITAA 1936 do not apply to the Taxpayer to determine whether the Taxpayer is deemed to have derived a capital gain in respect of the buy-back of the Company shares.

Detailed reasoning

Section 159GZZZP of the ITAA 1936 provides that, in an off-market share buy-back, only that part of the purchase price that is not debited against the capital account of the company will taken to be a dividend paid by the company. The remainder of the purchase price is taken not be a dividend for the purposes of the ITAA 1936 or ITAA 1997: subsection 159GZZZP(2) of the ITAA 1936.

Accordingly, the portion of the purchase price that is debited against the Company's capital account will be a distribution of share capital. The Taxpayer will have derived a capital gain under CGT event C2 if the capital proceeds from the share buy-back are more than the cost base of the shares: subsection 104-25(3) of the ITAA 1997.

However, as explained above, the Taxpayer purchased its shares in the Company from the Employee Entities on bare trust for the Company and, accordingly, the Taxpayer is effectively 'ignored' for the purposes of applying the provisions of the ITAA 1936 and ITAA 1997 in respect of the purchase of the shares. Instead, the provisions of the ITAA 1936 and ITAA 1997 are applied as though the Company has purchased the shares directly from the Employee Entities.

Furthermore, the share buy-back provisions of the ITAA 1936 and ITAA 1997 do not apply at the point when legal title of the Company shares transfers from the Taxpayer to the Company because the provisions have already been applied when the Taxpayer acquired the shares from the Employee Entities on bare trust with the Company as beneficiary with absolute entitlement to the trust property.

Question 3

Summary

There are no CGT consequences for the Company, the Taxpayer or the Company's shareholders in cancelling the shares under the ITAA 1997.

Detailed reasoning

No capital gain tax consequences for the Company

As explained at paragraph above, section 159GZZZN of the ITAA 1936 provides that where a company buys-back a share, the buy-back and any subsequent cancellation of the share is disregarded for the purposes of determining the company's taxable income or whether the company makes a capital gain or loss. Accordingly, there will be no CGT consequences under the ITAA 1997 for the Company when it buys-back its shares from the Employee Entities through the Taxpayer as bare trustee.

No capital gains tax consequences for the Taxpayer

There are no capital gains tax consequences for the Taxpayer because the Company shares have been purchased by the Taxpayer on bare trust for the Company, as explained under Question 2 above.

In any case, subsection 701-1(1) of the ITAA 1997 provides that if an entity is a subsidiary of a consolidated group for any period, it and any other subsidiary member of the group are taken to be a part of the head company of the group, rather than separate entities, during that period. Intra-group asset transfers, debt and shareholding are ignored for income tax purposes. Accordingly, any capital gain derived by the Taxpayer under the share buy-back is ignored.

No capital gains tax consequences for the Company shareholders

The arrangement involving the share buy-back and cancellation of shares by the Company does not constitute any CGT events involving any of the shares held by the current the Company shareholders.

It is noted, however, that it is likely that the value of the remaining shares in the Company will increase proportionally on the buy-back and cancellation of the relevant the Company shares, with no increase in cost base in the remaining Company shares. As a result, on the sale of the remaining shares by the Company's shareholders at some time in the future, more CGT might be payable than might be the case if the buy-back does not proceed.

Question 4 and Question 5

Summary

Although there is a trust estate over the Company shares, the creation of interests or the passing of interests in the trust assets will not result in a tax liability. Furthermore, the Taxpayer is not required to furnish any return on behalf of the trust.

Detailed reasoning

The taxation of trust income is generally governed by the provisions of Division 6 of Part III of the ITAA 1936. Relevantly, subsection 97(1) of the ITAA 1936 provides that where a resident beneficiary of a trust estate is presently entitled to a share of the income of the trust estate, the assessable income of the beneficiary shall include so much of that share of the net income of the trust estate as is attributable to a period when the beneficiary was a resident.

A trust estate is not specifically defined in the ITAA 1936 or the ITAA 1997. A trustee, however, is defined in subsection 6(1) of the ITAA 1936 to include, inter alia, every person appointed or constituted trustee by acts of parties, by order, declaration of a court, or by operation of law.

For the provisions of Division 6 to apply, however, 'income must arise or be derived by the trustee in virtue of some property or right in the nature of property which is vested in' the trustee or is under the trustee's control or of which the trustee is a fiduciary: DFC of T v Trustees of the Wheat Pool of Western Australia (1932) 48 CLR 5. Indeed, a trustee 'must stand in some relation to a proprietary right by virtue of which net income of the trust estate arises': Leighton v FC of T [2011] FCAFC 96 at paragraph 9.

Based on the terms of the bare trust over the Company shares, if the ATO and ASIC issue favourable rulings, the Taxpayer shall be deemed to have held the shares acquired from the Employee Entities on bare trust absolutely for the Company but on the basis that such shares are forthwith to be cancelled. Accordingly, the Taxpayer is acting in a fiduciary capacity in relation to any net income that arises from the shares in the Company.

The net income that arises from the shares in the Company held by the Taxpayer will be 'income of a trust estate' for the purposes subsection 97(1) of the ITAA 1936. The Company is the beneficiary that is presently entitled and therefore any net income is included in its assessable income. However, no such income arises during the short period that the bare trust exists and accordingly no net income of the trust estate is included in the Company's assessable income.

As there is no income from the trust at any time during the existence of the bare trust, and there are no CGT consequences upon the termination of the trust, no tax liability arises for the Company as the beneficiary, or for the Taxpayer as the trustee.

As trustee, the Taxpayer is ordinarily required to furnish a return on behalf of the trust. However, the ATO provides an exemption from the requirement to furnish a return for trustees of a Transparent Trust: PS LA 2000/2.

The exemption under PS LA 2000/2 applies to years of income both before and after the issue of the Practice Statement. The bare trust created over the Company shares is a Transparent Trust as defined in PS LA 2000/2 because it is a trust in which the beneficiary (the Company) of the trust estate has an absolute, indefeasible entitlement to the capital and the income of the trust: PS LA 2000/2 at paragraph 3. Accordingly, the Taxpayer is not required to furnish any return in relation to the trust.

Question 6

Summary

The provisions of Part IVA do not apply to the arrangement because there is no tax benefit.

Detailed reasoning

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

Before the Commissioner can exercise the discretion in subsection 177F(1) of the ITAA 1936, the requirements of Part IVA must be satisfied. These requirements are contained in section 177D of the ITAA 1936, namely:

· a taxpayer (referred to as the 'relevant taxpayer') has obtained, or would obtain but for section 177F obtain, a 'tax benefit' in connection with the scheme (paragraph 177D(a)); and

· having regard to the eight factors in paragraph 177D(b), it would be concluded that the scheme was entered into for the sole or dominant purpose of enabling the relevant taxpayer to receive the tax benefit.

The scheme:

For Part IVA of the ITAA 1936 to apply, the identified scheme must fall within the wide definition of 'scheme' in subsection 177A(1) of the ITAA 1936. In Federal Commissioner of Taxation v Hart [2004] HCA 26 at [43], Gummow and Hayne JJ held that the definition of 'scheme' (Hart):

'… is very broad. It encompasses not only a series of steps which together can be said to constitute a "scheme" or a "plan" but also (by its reference to "action" in the singular) the taking of but one step.'

For this private ruling, the Commissioner considers that the relevant scheme is the buying-back of the Company shares from the Employee Entities by the Company through an interposed entity (namely, the Taxpayer).

A tax benefit:

Part IVA of the ITAA 1936 cannot apply unless a taxpayer has obtained (or would obtain but for section 177F) a tax benefit in connection with a scheme. Subsection 177C(1) of the ITAA 1936 defines four kinds of tax benefit, relating broadly to:

· an amount not being included in the assessable income of the taxpayer of a year of income;

· a deduction being allowable to the taxpayer in relation to a year of income;

· a capital loss being incurred by the taxpayer during a year of income;

· a foreign tax credit being allowable to the taxpayer.

The identification of a tax benefit necessarily requires consideration of the income tax consequences, but for the operation of Part IVA, of an 'alternative hypothesis' or 'alternative postulate' and is what would have happened if that particular scheme had not been entered into or carried out: Hart. The Commissioner calls these alternative hypotheses 'counterfactuals': Law Administration Practice Statement PS LA 2005/24: Application of General Anti-Avoidance Rules (PS LA 2005/4).

On the facts of this private ruling, a potential counterfactual is if the Company had purchased the Company shares directly from the Employee Entities rather than through the bare trust arrangement with the Taxpayer. However, under this counterfactual, the share buy-back provisions under Division 16K of the ITAA 1936 would apply in the exact same way as they apply under the current scheme since the Taxpayer is already 'ignored' as a bare trust in respect of the purchase of the Company shares.

Therefore, the Commissioner considers that there is no 'tax benefit' as defined in subsection 177C(1) of the ITAA 1936 and, accordingly, the requirement in paragraph 177D(a) of the ITAA 1936 is not satisfied.

It is therefore unnecessary to consider the eight factors in paragraph 177D(b) of the ITAA 1936 to determine whether the scheme was entered into for the sole or dominant purpose of enabling the relevant taxpayer to receive the tax benefit, because there is no 'tax benefit' as required under paragraph 177D(a).