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Ruling

Subject: Off-market share buy-back

Question 1

Will the consideration that Shareholder is taken to have received or be entitled to receive in respect of the sale of a share in respect of the buy-back be the Capital Component of the purchase price, in accordance with section 159GZZZQ of the Income Tax Assessment Act 1936 (ITAA 1936), i.e. the purchase price will be reduced under subsection 159GZZZQ(4)(a) of the ITAA 1936 by the Dividend Component?

Answer

Yes.

Question 2

Will Shareholder be entitled to a tax offset under subsection 207-20(2) of the Income Tax Assessment Act 1997 (ITAA 1997) equal to the franking credit on the Dividend Component of the purchase price?

Answer

No.

Question 3

Will the Commissioner make a determination in relation to Shareholder under sections 45A or 45B of the ITAA 1936 that section 45C of the ITAA 1936 applies in relation to the whole, or part, of the capital component?

Answer

No.

Question 4

Will the Commissioner make a determination in relation to Shareholder under paragraph 204-30(3)(c) of the ITAA 1997 in relation to the buy-back?

Answer

Yes.

Question 5

Will the Commissioner make a determination in relation to Shareholder under paragraph 177EA(5)(b) of the ITAA 1997 in relation to the buy-back?

Answer

Yes.

This ruling applies for the following period:

2012-13 financial year.

The scheme commences on:

2012-13 financial year.

Relevant facts and circumstances

Corporate structure

Company A is an Australian resident for tax purposes.

Company A's ordinary shares are held by three shareholders:

· Shareholder

· Foreign Related Shareholder

· Foreign Unrelated Shareholder

Foreign Unrelated Shareholder is the majority shareholder of Company A.

Shareholder is an Australian resident for tax purposes.

Shareholder has been a shareholder of Company A since it was established in 199.

Shareholder's shareholding in Company A has remained consistent since 200X.

Foreign Related Shareholder is the ultimate parent of Shareholder.

Foreign Related Shareholder is not an Australian resident for tax purposes and does not have an Australian permanent establishment (PE).

Foreign Related Shareholder became a shareholder of Company A in 200X.

Foreign Related Shareholder's shareholding in Company A has remained consistent since 200X.

Foreign Unrelated Shareholder is not an Australian resident for tax purposes and does not have an Australian PE.

Shareholder and Foreign Related Shareholder are not associated with or related to Foreign Unrelated Shareholder.

The proposed buy-back scheme

Company A proposes to carry out an off-market share buy-back within the meaning of the term in subsection 159GZZZK(d) of the ITAA 1936 (the proposed buy-back).

The proposed buy-back will be conducted as an arm's length transaction.

Company A will buy-back its shares from Shareholder and Foreign Related Shareholder only.

Company A will pay the 'purchase price' per share under the proposed buy-back.

The purchase price in respect of the proposed buy-back is not less than the amount that would have been the market value of an Company A share at the time of the buy-back if the buy-back did not occur and was never proposed to occur.

Company A will use the 'average capital per share' methodology to determine the capital/dividend split of the purchase price to be received by Shareholder and Foreign Related Shareholder.

Consequent to the proposed share buy-back, Shareholder and Foreign Related Shareholder will hold no Company A shares.

The shareholding of the Y shareholders in Company A will remain the same as at the time of the ruling application until the proposed buy-back occurs.

All the shares sold by Shareholder under the proposed buy-back will be cancelled by Company A.

Commercial relationships and rational of the proposed buy-back

Shareholder has commercial contracts with Company B under which Shareholder sells a Product to Company B.

Shareholder also handles commercial discussions and negotiations (on commercial terms and prices) with Company B on behalf of Company A.

Company A is a producer of the Product.

A 'service contract' is entered into between Shareholder and Company A whereby Company A sells the Product it produces to Shareholder.

Company B is not an 'associate' of either Company A or Shareholder within the meaning provided under section 318 of the ITAA 1936.

Shareholder states that Company B does not wish to deal with Shareholder directly and that Company B no longer wishes to deal with Shareholder in any form.

Shareholder states that, because of the situation with Company B, Company A is keen to ensure that Shareholder and Foreign Related Shareholder are removed from the entire business, both from a trading and shareholding perspective.

Shareholder states that Company A proposes a two-step restructure being:

· The proposed buy-back of shares;

· A transfer of the commercial contracts between Shareholder and Company B to Company A in the current year.

Company A

Company A only has one class of share and all shares issued by Company A are ordinary shares.

Company A's share capital account is untainted for the purposes of section 197-50 of the ITAA 1997.

There has been no capital injection to Company A's share capital account since the restructure of Company A was requested.

There has been no return of capital to Company A shareholders since 200X.

To record the proposed buy-back, Company A will record a debit against amounts standing to credit in its share capital account and debit retained earnings.

Company A will use current cash reserves to fund the proposed buy-back.

Company A's retained earnings does not include not unrealised or untaxed profits.

Company A has a pattern of paying franked dividends,

Shareholder

Shareholder will make a capital gain on its disposal of its Company A shares.

Shareholder had net capital losses carried forward to the current year of income. After allowing for other capital gains made during the year, Shareholder will continue to have net capital losses carried forward to future years of income.

Shareholder has income tax losses carried forward to later income years.

Shareholder will on-pay the purchase price per share received from Company A to Foreign Related Shareholder after the transaction, in the current financial year, as a dividend.

Assumptions

The Dividend Component, being the difference between the purchase price in respect of the buy-back, as defined in section 159GZZZM of the ITAA 1936, of a Company A share and the part of that purchase price which is debited against amounts standing to the credit of Company A's share capital account is a frankable distribution in accordance with section 202-40 of the ITAA 1997.

The Dividend Component will be fully franked by Company A in accordance with section 202-5 of the ITAA 1997.

Relevant legislative provisions

Income Tax Assessment Act 1936 subsection 6(1).

Income Tax Assessment Act 1936 subsection 44(1).

Income Tax Assessment Act 1936 section 45A.

Income Tax Assessment Act 1936 subsection 45A(2).

Income Tax Assessment Act 1936 subsection 45A(3)(b).

Income Tax Assessment Act 1936 section 45B.

Income Tax Assessment Act 1936 paragraph 45B(1)(a).

Income Tax Assessment Act 1936 paragraph 45B(2)(b).

Income Tax Assessment Act 1936 paragraph 45B(2)(c)

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 subsection 45B(9).

Income Tax Assessment Act 1936 section 45C.

Income Tax Assessment Act 1936 section 159GZZZM.

Income Tax Assessment Act 1936 section 159GZZZP.

Income Tax Assessment Act 1936 subsection 159GZZZP(1).

Income Tax Assessment Act 1936 section 159GZZZQ.

Income Tax Assessment Act 1936 subsection 159GZZZQ(1).

Income Tax Assessment Act 1936 subsection 159GZZZQ(2).

Income Tax Assessment Act 1936 subsection 159GZZZQ(3).

Income Tax Assessment Act 1936 subsection 159GZZZQ(4).

Income Tax Assessment Act 1936 subsection 159GZZZQ(8).

Income Tax Assessment Act 1936 section 177EA.

Income Tax Assessment Act 1936 subsection 177EA(3).

Income Tax Assessment Act 1936 subsection 177EA(17).

Income Tax Assessment Act 1997 section 202-5.

Income Tax Assessment Act 1997 section 202-40.

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(7).

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

Income Tax Assessment Act 1997 subsection 207-20(1).

Income Tax Assessment Act 1997 subsection 207-20(2).

Income Tax Assessment Act 1997 subsection 207-145(1).

Income Tax Assessment Act 1997 subsection 995-1(1).

Reasons for decision

Question 1

Summary

The consideration that Shareholder is taken to have received or to be entitled to receive in respect of the sale of a share in respect of the buy-back is the Capital Component calculated in accordance with section 159GZZZQ of the Income Tax Assessment Act 1936 (ITAA 1936).

Detailed reasoning

The consideration that Shareholder is taken to have received in respect of the sale of a share in respect of the off-market buy-back is calculated in accordance with section 159GZZZQ of the ITAA 1936.

Pursuant to subsection 159GZZZQ(1) of the ITAA 1936, the amount Shareholder will be taken to have received or to be entitled to receive as consideration in respect of the sale of the share is an amount equal to the 'purchase price' in respect of the buy-back. The 'purchase price' in respect of the buy-back is the amount of money Shareholder receives or is entitled to receive as a result of or in respect of the buy-back: section 159GZZZM of the ITAA 1936.

The consideration amount calculated under subsection 159GZZZQ(1) of the ITAA 1936 may be altered by the operation of subsections 159GZZZQ(2) and 159GZZZQ(3) of the ITAA 1936

Subsection 159GZZZQ(2) of the ITAA 1936 operates where the purchase price is less than the amount that would have been 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. On the facts provided, subsection 159GZZZQ(2) does not operate in this case.

Subsection 159GZZZQ(3) of the ITAA 1936 operates to reduce the consideration if there is a 'reduction amount' in respect of the buy-back. A 'reduction amount' is an amount worked out under subsection 159GZZZQ(4) of the ITAA 1936. In broad terms, a reduction amount is the amount of the purchase price that is taken to be a dividend by section 159GZZZP of the ITAA 1936 and is either included in the seller's assessable income in any year of income or is an eligible non-capital amount.

Subsection 159GZZZP(1) of the ITAA 1936 provides that the difference between

· the purchase price; and

· the part (if any) of the purchase price in respect of the buy-back of the share or non-share equity interest which is debited against amounts standing to the credit of:

· the company's share capital account if it is a share that is bought back; or

· the company's share capital account or non-share capital account if it is a non-share equity interest that is bought back;

· is taken to be a dividend paid by the company ('the Dividend Component').

Law Administration Practice Statement 2007/09 Share Buy-Backs ('PSLA 2007/9') provides guidance on the Commissioner's approach to various taxation laws in connection with off-market share buy-backs. In relation to the dividend/capital split, paragraph 61 of PSLA 2007/9 provides that the Tax Office considers that there are a number of acceptable methodologies for ascertaining the capital/dividend split, although not all have equal applicability in every case. The question becomes which is the most appropriate methodology in each case.

Company A will use the Average Capital per Share (ACPS) methodology to determine the dividend/capital split of arising from the buy-back. Paragraph 62 of PSLA 2007/9 provides that the ACPS is obtained by dividing Company A's ordinary issued capital by the number of shares on issue. The amount derived is a reasonable estimate of any capital component of the split. The balance of any buy-back price would be a dividend. Paragraph 62 of PSLA 2007/9 also states that ACPS should, prima facie, be applied to determine the capital component in an off-market share buy-back.

The purchase price to be received by Shareholder will be allocated under ACPS methodology to reach the Capital Component and Dividend Component.

The Dividend Component calculated under section 159GZZZP(1) of the ITAA 1936 would be included in Shareholder's assessable income under subsection 44(1) of the ITAA 1936.Therefore, the Dividend Component is a reduction amount for the purpose of subsection 159GZZZQ(4) of the ITAA 1936.

The reduction amount calculated in subsection 159GZZZQ(4) of the ITAA 1936 can itself be reduced by the operation of subsection 159GZZZQ(8) of the ITAA 1936. Subsection 159GZZZQ(8) of the ITAA 1936 does not apply in this case as Shareholder will make a capital gain in respect of the share buy-back and will not incur a capital loss.

After reducing the consideration calculated under subsection 159GZZZQ(1) of the ITAA 1936 by the reduction amount, the consideration Shareholder is taken to receive in respect of the buy-back is the Capital Component per share.

Question 2

Subsection 207-20(1) of the ITAA 1997 provides the general rule that if an entity makes a franked distribution to another entity, the assessable income of the receiving entity, for the income year in which the distribution is made, includes the amount of the franking credit on the distribution. A 'franked distribution' is a distribution that is franked in accordance with section 202-5 of the ITAA 1997: subsection 995-1 of the ITAA 1997. Subsection 207-20(2) of the ITAA 1997 provides that the receiving entity is entitled to a tax offset for the income year in which the distribution is made. The tax offset is equal to the franking credit on the distribution.

The difference between the purchase price per share and the part of the purchase price per share debited against amounts standing to the credit of the share capital account pursuant to subsection 159GZZZP(1)(b) of the ITAA 1936 is the 'dividend component'.

It is assumed that the Dividend Component is a frankable distribution in accordance with section 202-40 of the ITAA 1997; and that the distribution will be full franked by Company A in accordance with section 202-5 of the ITAA 1997.

As Shareholder will be in receipt of a franked distribution from Company A, pursuant to the general rule in section 207-20 of the ITAA 1997 Shareholder would be entitled to a tax offset for the income year in which the distribution is made.

However, the general rule in section 207-20 of the ITAA 1997 is subject to modification by more specific rules elsewhere in Division 207 of the ITAA 1997. Such specific rules would include section 207-145 of the ITAA 1997, which negates the gross up and tax offset treatment of the general rule if the conditions for its application are met.

In the present circumstances, as the responses to Issues 4 and 5 confirm, it is considered that both subparagraphs 207-145(1)(b) and (c) of the ITAA 1997 would be satisfied. As such, subparagraphs 207-145(e) and (f) of the ITAA 1997 would operate to deny Shareholder the general gross up and tax offset treatment of section 207-20 of the ITAA 1997.

Question 3

Summary

The Commissioner will not make a determination in relation to Shareholder under sections 45A or 45B of the ITAA 1936 that section 45C of the ITAA 1936 applies in relation to the whole, or part, of the capital component.

Detailed reasoning

Sections 45A and 45B of the ITAA 1936 are anti-avoidance provisions which, if they apply, allow the Commissioner to make a determination that section 45C of the ITAA 1936 applies to a capital benefit. Broadly, if the Commissioner makes such a determination, all or part of the capital benefit is taken to be an unfranked dividend paid by a Company A to the shareholder or relevant taxpayer.

Section 45A - Streaming of dividends and capital benefits

Broadly, subsection 45A(1) of the ITAA 1936 provides that section 45A of the ITAA 1936 applies if a Company A, streams the provision of capital benefits and the payment of dividends to its shareholders in such a way that:

· the capital benefits are, or apart from this section would be, received by shareholders (the advantaged shareholders) who would, in the year of income in which the capital benefits are provided, derive a greater benefit from the capital benefits than other shareholders; and

· it is reasonable to assume that the other shareholders (the disadvantaged shareholders) have received, or will receive, dividends.

Where the provision applies, 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.

Subsection 45A(3) of the ITAA 1936 defines the 'provision of a capital benefit' to include a distribution of share capital to a shareholder. Payment of the Capital Component under the proposed buy-back would therefore constitute the provision of a capital benefit.

However, Company A cannot be said to have 'streamed' capital benefits to one class of shareholders and dividends to another class of shareholders in this case. The shareholders (Shareholder and Foreign Related Shareholder) who will receive the capital benefit in the form of the Capital Component will also receive the Dividend Component of the buy-back. As it cannot be said that a capital benefit will be provided to Shareholder and dividends to Foreign Related Shareholder based upon their respective ability to take advantage of capital benefits, section 45A of the ITAA 1936 will not apply.

Consequently, the Commissioner will not make a determination under subsection 45A(2) of the ITAA 1936 that section 45C of the ITAA 1936 applies in relation to the whole or a part of the capital benefit.

Section 45B - Schemes to provide certain benefits

To the extent it is relevant in this case, the purpose of section 45B of the ITAA 1936 is to ensure that certain amounts paid, allocated or distributed in substitution for dividends are treated as dividends for taxation purposes: paragraph 45B(1)(a) of the ITAA 1936.

Subsection 45B(2) of the ITAA 1936 provides that section 45B of the ITAA 1936 applies if:

· there is a scheme under which a person is provided with a capital benefit by a company ; and

· under the scheme, a taxpayer (the relevant taxpayer), who may or may not be the person provided with the capital benefit, obtains a tax benefit;

· 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 a taxpayer (the relevant taxpayer) to obtain a tax benefit.

(a) A scheme to provide a capital benefit

Subsection 45B(10) of the ITAA 1936 provides that a 'scheme' for the purpose of section 45B of the ITAA 1963 has the meaning given by subsection 995-1(1) of the ITAA 1997. Under that section, scheme means:

· any arrangement; or

· any scheme, plan, proposal, action, course of action or course of conduct, whether unilateral or otherwise.

Under subsection 45B(5) of the ITAA 1936, a reference to a person being 'provided with a capital benefit' includes a reference to a distribution of share capital to a person. Subsection 6(1) of the ITAA 1936 defines 'person' to include a company.

As Shareholder receives a distribution of share capital under the buy-back (by way of the Capital Component), the buy-back constitutes a scheme to provide a capital benefit.

(b) Obtain a tax benefit

Shareholder is the 'relevant taxpayer' for the purpose of the provision. 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. Therefore by receiving the capital benefit described above, Shareholder is also taken to receive a 'tax benefit' under the scheme.

(c) For a purpose of enabling a taxpayer to obtain a tax benefit

The purpose test in section 45B of the ITAA 1936 examines why the particular proportions (as between the Dividend Component and Capital Component of the purchase price) were chosen by Company A. To apply section 45B of the ITAA 1936 to the proposed buy-back 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. The section is intended to prevent Company A distributing capital in substitution for a dividend substantially because of its preferential tax treatment in the hands of shareholders.

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 in this case would include Company A, Foreign Unrelated Shareholder, Shareholder and Foreign Related Shareholder. To identify the requisite purpose, the Commissioner must consider the non-exhaustive list of 'relevant circumstances' in subsection 45B(8) of the ITAA 1936.

In this case, the purchase price includes both a Capital Component and a Dividend Component, the proportions of which were determined on the basis of the ACPS methodology. Under the ACPS calculation, the Capital Component represents the amount debited to the share capital account of Company A. As the Capital Component reflects a return of capital originally contributed to Company A, the capital benefit cannot be said to be attributable to the profits of Company A: paragraph 45B(8)(a) of the ITAA 1936. Rather, the Dividend Component is the amount that is attributable to the profits of Company A and Company A has a history of paying dividends, albeit of smaller value than the Dividend Component: paragraph 45B(8)(b) of the ITAA 1936.

The tax characteristics of Shareholder are also relevant considerations. Shareholder acquired its shares in Company A after 19 September 1985. At the time of the proposed buy-back, the cost base of the shares will be less than the value of the capital benefit being received. Shareholder will therefore make a capital gain on receipt of the Capital Component. As an Australian tax resident, the capital gain is taxable in the Australia. These factors indicate that Shareholder would have a tax preference for the distribution of profits over capital: paragraphs 45B(8)(d),(e), (f) of the ITAA 1936. However, Shareholder has net capital losses carried forward from a prior year available to absorb the current year capital gains which may point towards a preference for capital over profit: paragraph 45B(8)(c) of the ITAA 1936.

The distribution in this case will be made in the context of a proposed share-buy back. After the distribution, Shareholder's shares in Company A will be cancelled and Shareholder will have no further interest in Company A: paragraphs 45B(8)(g) of the ITAA 1936 This factor also weighs against finding that the Capital Component was paid in substitution for a dividend.

Finally, none of the matters outlined in subparagraphs to in 177D(b)(i) to (viii) of the ITAA 1936 suggest that the Capital Component in this case is paid in substitution for dividends which would otherwise have been paid: paragraph 45B(8)(k) of the ITAA 1936. The practical implications of the scheme for Shareholder are consistent with the Capital Component being, in form and substance, a distribution of share capital.

Conclusion

Therefore, having regard to the relevant circumstances of the scheme, it cannot be concluded that the buy-back will be carried out a purpose other than a merely incidental purpose of enabling Shareholder to obtain a tax benefit. Accordingly, the Commissioner will not make a determination in relation to Shareholder under subsection 45B(3) of the ITAA 1936, that section 45C of the ITAA 1936 applies to the whole, or a part, of the capital benefit represented by the return of capital.

Question 4

Subsection 204-30(1) of the ITAA 1997 provides that the Commissioner may 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 member that derives the greater benefit from franking credits is the favoured member. The member that receives the lesser imputation benefits is the disadvantaged member.

The relevant distribution to consider in this case is the fully franked Dividend Component of the buy-back.

Subsection 204-30(6) of the ITAA 1997 explains when a member of an entity receives an 'imputation benefit' as a result of a distribution. In this case, Shareholder would receive imputation benefits in the form of a tax offset under Division 207 and a franking credit arising in its franking account: paragraph 204-30(6)(a), (c) of the ITAA 1997. Foreign Related Shareholder would receive an imputation benefit in the form of an exemption from withholding tax: paragraph 204-30(6)(e) of the ITAA 1997. Foreign Unrelated Shareholder would receive no imputation benefits as it does not participate in the buy-back.

Subsections 204-30(8) to (10) of the ITAA 1997 identify when a member of an entity derives a greater benefit from franking credits than another member. In this case, Shareholder derives a greater benefit from franking credits than both Foreign Related Shareholder and Foreign Unrelated Shareholder because they are both foreign residents: paragraph 204-30(8)(a) of the ITAA 1997. Therefore, Shareholder is the favoured member and Foreign Unrelated Shareholder is the disadvantaged member.

Thus, it would appear that the proposed buy-back would fit within the legislative requirements to be regarded as streaming for the purposes of section 204-30 of the ITAA 1997. The proposed buy-back would also fit within the common understanding of the concept of 'streaming', which the Commissioner understands to refer to a company 'selectively directing the flow of franked distributions to those members who can most benefit from the imputation credits' (see paragraph 3.28 of the Explanatory Memorandum to the New Business Tax System (Imputation) Bill 2002).

As the conditions in subsection 204-30(1) of the ITAA 1997 are satisfied, the Commissioner is empowered to make one of the determinations in subsection 204-30(3) of the ITAA 1997. Relevantly, the Commissioner may make a determination 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

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

In order to remove the benefits achieved by the streaming, the Commissioner would make a determination under paragraph 204-30(3)(c) of the ITAA 1997 that no imputation benefit is to arise for Shareholder in relation to the buy-back.

Question 6

Summary

The Commissioner would make a determination under paragraph 204-30(3)(c) of the ITAA 1997 to deny Shareholder imputation benefits in relation to the buy-back. As such, Shareholder would not be taken to receive an imputation benefit as a result of the distribution, as required by paragraph 177EA(3)(d) of the ITAA 1936, meaning that section 177EA of the ITAA 1936 would have no application in this case.

However, if the Commissioner did not make a determination under paragraph 204-30(3)(c) of the ITAA 1997 to deny Shareholder imputation benefits, the Commissioner considers that the requirements of subsection 177EA(3) of the ITAA 1936 are satisfied and the Commissioner would make a determination in relation to Shareholder under paragraph 177EA(5)(b) of the ITAA 1997 in relation to the buy-back.

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 imputation benefits. The provision can apply to off-market share buy-backs which include a franked dividend component.

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.

Paragraph 177EA(3)(a) of the ITAA 1936 is satisfied because the proposed buy-back is a scheme to dispose of membership interests (shares) in a corporate tax entity (Company A): paragraph 177EA(14)(a) of the ITAA 1936.

Paragraphs 177EA(3)(b) and (c) of the ITAA 1936 are satisfied on the assumption that the Dividend Component of the buy-back is a frankable distribution, fully franked by Company A.

Paragraph 177EA(3)(d) of the ITAA 1936 is also satisfied as Shareholder could reasonably be expected to receive imputation benefits as a result of the distribution.

Accordingly, the issue to be determined is whether, having regard to the relevant circumstances of the scheme, it would be concluded that, on the part of Company A, Shareholder or any other relevant party, there is a purpose more than merely an incidental purpose of conferring an imputation benefit under the scheme: paragraph 177EA(3)(e) of the ITAA 1936.

In arriving at a conclusion as to purpose, 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 encompass a range of circumstances which taken individually or collectively could indicate the requisite purpose. Due to the wide range of these circumstances, some may or may not be present at any one time in any one scheme.

The pertinent relevant circumstances under subsection 177EA(17) of the ITAA 1936, and their application to the scheme that is the subject of this Ruling, are discussed below.

The proposed share buy-back results in Shareholder selling all of its shares back to Company A so that Shareholder will no longer be a shareholder in Company A. This proposed buy-back is being undertaken in the context of Shareholder and Foreign Related Shareholder (being related entities) selling out of their interest in Company A. The proposed buy-back results in Shareholder deriving a greater benefit from franking credits than Foreign Unrelated Shareholder. Moreover, it is reasonable to conclude that apart from the scheme, Company A would have retained the franking credits or would have used the franking credits to pay a franked distribution to all its shareholders consistent with its dividend payment history. The proposed buy-back seeks to liberate franking credits from Company A only to selected shareholders, particularly those who are exiting their investment in Company A, but not all. These factors tend to point towards the existence of the requisite purpose: paragraphs 177EA(17)(b) and (c) of the ITAA 1936.

Additionally, paragraph 177EA(17)(j) of the ITAA 1936 invites consideration of the Part IVA factors, being the matters referred to in subparagraphs 177D(b)(i) to (viii) of the ITAA 1936.

Shareholder seeks to end its shareholding in Company A. Pursuant to the "Company A Joint Venture Agreement", Foreign Unrelated Shareholder (as the remaining shareholder) had the first right to acquire the Company A shares held by Shareholder. A direct purchase by Foreign Unrelated Shareholder is the most straightforward and ordinary commercial method for achieving the outcome sought, consistent with the agreement reached by the parties in the "Company A Joint Venture Agreement". However, given the cost base of Shareholder's investment in Company A, it would appear that the direct sale of shares from Shareholder to Foreign Unrelated Shareholder would result in a significant capital gain to Shareholder.

By way of contrast, the form of the scheme is to selectively liberate a significant amount of franking credits in Company A to Shareholder and Foreign Related Shareholder to shelter the potential tax liability arising from the capital gain that Shareholder would have been subject to in a straightforward sale, using the mechanism of Division 16K of the ITAA 1936 to facilitate a selective distribution for tax purposes. The substance of the transaction is essentially a sale by Shareholder and Foreign Related Shareholder of its shareholding in Company A but the form of the scheme delivers significant amount of franking credits to the exiting party without also delivering the same level of franking credits into the hands of the remaining shareholder at the same time.

The manner in which the scheme is carried out, its form and substance, the results achieved by the scheme and the improved financial position of Shareholder arising out of the scheme are all factors which suggest the scheme is to be carried out for a more than incidental purpose of allowing Shareholder to obtain imputation benefits.

On a balanced consideration of all relevant circumstances the Commissioner considers that section 177EA of the ITAA 1936 would apply to the proposed buy-back. Objectively, the Commissioner concludes that the proposed scheme is being entered into for the purpose of obtaining a tax advantage relating to franking credits by selectively delivering those credits into the hands of exiting shareholders but not to the remaining shareholder at the same time. This is so notwithstanding that there is a commercial reason for Shareholder exiting the investment because the purpose of obtaining imputation benefit is not merely incidental to that exit.

Where section 177EA of the ITAA 1936 applies the Commissioner has a discretion pursuant to subsection 177EA(5) of the ITAA 1936 to make a determination that a franking debit is to arise in respect of each distribution or that no imputation benefit is to arise in respect of a distribution that is made to the relevant taxpayer. To effectively remove the imputation benefits gained under the scheme in this case, the Commissioner would make a determination under paragraph 177EA(5)(b) of the ITAA 1936 to deny imputation benefits to Shareholder.