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Ruling

Subject: Share buy-back

Question 1

Is Company B entitled to a tax offset of the $X franking credits under subsection 207-20(2) of the Income Tax Assessments Act 1997 (ITAA 1997) in respect of the off-market share buy-back dividend that was made to it by Company A in early 2012?

Answer

Yes. Please see our 'Reasons for decision'.

Question 2

Can Company B allocate the maximum franking credits on the distribution statements that are given to each of the shareholders who participated in the early 2012 off-market share buy-back as per subsection 202-60(2) of the ITAA 1997?

Answer

Yes. Please see our 'Reasons for decision'.

Question 3

Can Company B debit its franking account by the total franking credits of $U on the certain date in early 2012 as per subsection 205-30(1) of the ITAA 1997?

Answer

Yes. Please see our 'Reasons for decision'.

Question 4

Will the Commissioner determine under subsection 202-75(5) of the ITAA 1997 that Company B may give the off-market share buy-back dividend distribution statements to the participating shareholders before the end of November 2012?

Answer

Yes. Please see our 'Reasons for decision'.

This ruling applies for the following periods:

1 July 2011 to 30 June 2012

The scheme commences on:

1 July 2011

Relevant facts and circumstances

1. Company B is a resident private company who held the majority of the issued ordinary shares in Company A.

2. In 2011, shareholders X and Y announced their intention to sell their shareholding in Company B. Their intention was a result of there being certain circumstances between Company B's shareholders for some years.

3. In late 2011, Company B paid a non-refundable deposit to X and Y to sell their shares pursuant to what was at that time the proposed off-market share buy-back.

4. Prior to the off-market share buy-back, Company B had:

· A issued ordinary shares at $2 each, all of which were held by resident individuals

· an untainted share capital account

· a history of paying regular dividends, and

· a surplus in its franking account.

5. In early 2012, Company A undertook the earlier off-market share buy-back where it bought back Company B's shares for $Z, and subsequently cancelled those shares. On that same date, Company B received a franked dividend of $Y, which included $X franking credits

6. Later in the same month 2012, Company B undertook the off-market share buy-back where it bought back, and subsequently cancelled, the ordinary shares of all but one of its shareholders for a total of $W.

7. The off-market share buy-back agreement was executed and the procedures laid out in the Corporations Act 2001 relating to share buy-backs were followed, including the lodgment of Notices of General Meeting with ASIC on certain date early 2012.

8. Company B's share price was determined by reference to a valuation.

9. Subsequent to the off-market share buy-back, Company B had one remaining shareholder.

Relevant legislative provisions

Income Tax Assessment Act 1936 Section 45A,

Income Tax Assessment Act 1936 Section 45B,

Income Tax Assessment Act 1936 Section 159GZZZM,

Income Tax Assessment Act 1936 Section 159GZZZN,

Income Tax Assessment Act 1936 Section 159GZZZP,

Income Tax Assessment Act 1936 Section 177C,

Income Tax Assessment Act 1936 Paragraph 177D(b),

Income Tax Assessment Act 1936 Section 177EA,

Income Tax Assessment Act 1936 Subsection 177EA(3),

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

Income Tax Assessment Act 1936 Paragraph 177EA(17)(a),

Income Tax Assessment Act 1936 Paragraph 177EA(17)(b),

Income Tax Assessment Act 1936 Paragraph 177EA(17)(c),

Income Tax Assessment Act 1936 Paragraph 177EA(17)(f),

Income Tax Assessment Act 1936 Paragraph 177EA(17)(g),

Income Tax Assessment Act 1936 Paragraph 177EA(17)(ga),

Income Tax Assessment Act 1936 Paragraph 177EA(17)(h),

Income Tax Assessment Act 1936 Paragraph 177EA(17)(i),

Income Tax Assessment Act 1936 Paragraph 177EA(17)(j),

Income Tax Assessment Act 1997 Section 67-25,

Income Tax Assessment Act 1997 Paragraph 202-5(a),

Income Tax Assessment Act 1997 Paragraph 202-5(b),

Income Tax Assessment Act 1997 Paragraph 202-5(c),

Income Tax Assessment Act 1997 Section 202-20,

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

Income Tax Assessment Act 1997 Section 202-45,

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

Income Tax Assessment Act 1997 Subsection 202-60(1),

Income Tax Assessment Act 1997 Subsection 202-60(2),

Income Tax Assessment Act 1997 Subsection 202-75(1),

Income Tax Assessment Act 1997 Subsection 202-75(3),

Income Tax Assessment Act 1997 Subsection 202-75(5),

Income Tax Assessment Act 1997 Section 204-30,

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

Income Tax Assessment Act 1997 Subsection 204-30(7),

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

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

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

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

Income Tax Assessment Act 1997 Subsection 205-15(1),

Income Tax Assessment Act 1997 Subsection 205-30(1),

Income Tax Assessment Act 1997 Subsection 205-40(1),

Income Tax Assessment Act 1997 Subsection 207-20(1),

Income Tax Assessment Act 1997 Subsection 207-20(2),

Income Tax Assessment Act 1997 Section 207-70,

Income Tax Assessment Act 1997 Subsection 207-75(1),

Income Tax Assessment Act 1997 Subsection 960-120(1) and

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

Reasons for decision

Question 1

Summary

Company B is entitled to a tax offset of the $X franking credits under subsection 207-20(2) of the Income Tax Assessment Act 1997 (ITAA 1997) in respect of the off-market share buy-back dividend that was made to it by Company A in early 2012.

Detailed reasoning

Section 207-70 of the ITAA 1997 provides that unless Company B satisfies the residency requirement:

· no amount of the $X franking credits can be included in its assessable income for the income year ended 30 June 2012 under subsection 207-20(1) of the ITAA 1997, and

· it is not entitled to a tax offset of the $X franking credits under subsection 207-20(2) of the ITAA 1997.

Company B will satisfy the residency requirement under subsection 207-75(1) as it was a resident company as at the date on which the off-market share buy-back dividend was made.

In conclusion, Company B is entitled to a tax offset of the $X franking credits under subsection 207-20(2) of the ITAA 1997 in respect of the off-market share buy-back dividend that was made to it by Company A in early 2012.

Question 2

Summary

Company B can allocate the maximum franking credits on the distribution statements that are given to each of the participating shareholders in the early 2012 off-market share buy-back as per subsection 202-60(2) of the ITAA 1997.

Detailed reasoning

For the purposes of section 159GZZZM of the Income Tax Assessment Act 1936 (ITAA 1936), the total purchase price of the shares bought back by Company B from the participating shareholders will be $W.

Section 159GZZZN of the ITAA 1936 provides that there will be no income tax or CGT consequences for Company B in respect of the off-market share buy-back.

The $T capital component of the off-market share buy-back, representing the debit to Company B's untainted share capital account, has been determined by the average capital per share (ACPS) method, in which Company B applied the $2 per issued ordinary share to the ordinary shares it bought back. As per Law Administration Practice Statement PSLA 2007/9, the ACPS method is the Commissioner's preferred method of calculating the capital component and provides a strong presumption that capital streaming has not occurred. As such, it is accepted that the off-market share buy-back does not give rise to the capital streaming anti-avoidance provisions of sections 45A and 45B of the ITAA 1936.

As per section 159GZZZP of the ITAA 1936, the $V difference between the $W purchase price and the $T debit to Company B's share capital account, will be taken to be the total dividends paid to the shareholders that participated in the off-market share buy-back.

As an Australian resident company that satisfies the residency requirement of section 202-20 of the ITAA 1997 (paragraph 202-5(a) of the ITAA 1997), Company B can frank each of its off-market share buy-back dividends if they are frankable distributions (paragraph 202-5(b) of the ITAA 1997), and franking credits are allocated to each of the dividends (paragraph 202-5(c) of the ITAA 1997).

As per subsection 202-40(1) of the ITAA 1997 Company B's off-market share buy-back dividends will be frankable distributions if they are not unfrankable distributions under section 202-45 of the ITAA 1997 (a distribution by a corporate tax entity is defined by subsection 960-120(1) of the ITAA 1997 to include a dividend by a company). Of relevance is paragraph 202-45(c) of the ITAA 1997, which provides that so much of the off-market share buy-back purchase price that exceeds the market value of the shares at the time of off-market share buy-back is an unfrankable distribution. The Commissioner accepts the methodology that Company B has adopted to determine the market value of its ordinary shares, meaning there will be no such difference, and as a result no part of the off-market share buy-back dividends will be unfrankable distributions.

Under subsection 202-60(1) of the ITAA 1997 the amount of franking credits Company B can allocate on the distribution statements that are given to the participating shareholders is the maximum franking credits. As the off-market share buy-back dividends will be fully franked, its total maximum franking credits will be $U as calculated by the formula in subsection 202-60(2) of the ITAA 1997.

In conclusion, subject to the specific anti-avoidance provision of section 204-30, and if applicable, the general anti-avoidance provision of section 177EA of the ITAA 1936, Company B can allocate the maximum franking credits on the distribution statements that are given to each of the participating shareholders in the early 2012 off-market share buy-back as per subsection 202-60(2) of the ITAA 1997.

Section 204-30 of the ITAA 1997

Section 204-30 of the ITAA 1997 was introduced as a specific anti-avoidance provision to apply where a company streams dividends so as to provide franking credit benefits to shareholders who benefit most, in preference to other shareholders.

As resident recipients of a franked dividend from Company B, each of the participating shareholders will be required to gross-up the distribution under subsection 207-20(1) of the ITAA 1997 and be entitled to a tax offset equal to the franking credits under subsection 207-20(2) of the ITAA 1997. Consequently, upon their receipt of the franked dividend, each of the participating shareholders will be taken to have received an imputation benefit under paragraph 204-30(6)(a) of the ITAA 1997.

Subsection 204-30(7) provides that subsection 204-30(8) of the ITAA 1997 lists the instances in which each of the participating shareholders will be taken to derive a greater benefit from franking credits than Company B's other shareholder, Z. The relevant instances with respect to the off-market share buy-back are as follows:

· Z is a resident individual, and therefore not a foreign resident (paragraph 204-30(8)(a) of the ITAA 1997).

· Z is a resident individual, and therefore would be entitled to a tax offset under subsection 207-20(2) of the ITAA 1997 (paragraph 204-30(8)(b) of the ITAA 1997).

· The participating shareholders and Z would be entitled to a refund of any excess franking credits under section 67-25 of the ITAA 1997, as they are all resident individuals (paragraph 204-30(8)(c) of the ITAA 1997).

After considering the relevant instances above, the Commissioner is of the view that section 204-30 of the ITAA 1997 does not apply to the off-market share buy-back as Company B has not streamed the franked dividends in such a manner so as to provide greater franking credit benefits to the participating shareholders, in preference to Z.

Section 177EA of the ITAA 1936

As the specific anti-avoidance provision of section 204-30 of the ITAA 1997 does not apply, the general anti-avoidance provision of section 177EA of the ITAA 1936 must be considered.

Section 177EA of the ITAA 1936 applies to a wide range of schemes to obtain a tax advantage in relation to imputation credits. In essence, it applies to schemes for the disposition of shares or an interest in shares, where a franked distribution is paid or payable in respect of the shares or an interest in shares. This would include an off-market share buy-back with a franked dividend component.

Specifically, subsection 177EA(3) of the ITAA 1936 provides that this section 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 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, a 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.

In the present case, the conditions in paragraphs 177EA(3)(a) to 177EA(3)(d) of the ITAA 1936 will be satisfied. Accordingly, the issue is whether as per paragraph 177EA(3)(e) of the ITAA 1936, having regard to the relevant circumstances of the scheme, it would be concluded that, on the part of the company, the shareholders or any other relevant party, there is a more than merely an incidental purpose of conferring an imputation benefit under the scheme. Under the off-market share buy-back, the relevant taxpayers are the participating shareholders and the scheme comprises the circumstances surrounding the off-market share buy-back.

In coming to the conclusion of whether or not section 177EA of the ITAA 1997 applies to the off-market share buy-back, the Commissioner has had regard to all of the relevant circumstances of the scheme, as outlined in subsection 177EA(17) of the ITAA 1936. These listed circumstances encompass a range of circumstances which, taken individually or collectively, indicate the requisite purpose. Due to the diverse nature of these circumstances, some may not be present at any one time in any one scheme. The relevant circumstances that apply to this off-market share buy-back are as follows:

· Each of the participating shareholders held their ordinary shares for at least five years, and as such were exposed to all of the risks and opportunities that arose because of ordinary share ownership during these substantial periods of time (paragraph 177EA(17)(a) of the ITAA 1936). This would point away from the requisite purpose.

· Each of the participating shareholders, like Z, would have had a top marginal tax rate of 45% applied to the off-market share buy-back dividends they received (paragraph 177EA(17)(b) of the ITAA 1936). This would point away from the requisite purpose.

· If the off-market share buy-back did not occur, Company B would have retained the $U total franking credits paid to the participating shareholders and in time, based on its history of regularly paying franked dividends, would have used these franking credits to pay franked dividends to Z (paragraph 177EA(17)(c) of the ITAA 1936). This would point away from the requisite purpose.

· The total off-market share buy-back purchase price of $W was not calculated by reference to the franking credits paid to the participating shareholders (paragraph 177EA(17)(f) of the ITAA 1936). This would point away from the requisite purpose.

· There was no tax or capital loss associated with the payment of the off-market share buy-back dividends (paragraph 177EA(17)(g) of the ITAA 1936). This would point away from the requisite purpose.

· As Company B is not a reporting entity, its 30 June 2011 balance sheet does not disclose an amount of 'Future Income Tax Benefits'. Only the valuation increase in respect of its real property investments is an unrealised or untaxed profit, as its shareholding in Company A was a pre-CGT asset. The Commissioner accepts that the off-market share buy-back dividend was sourced by the $W Company B received from Company A in respect of its Company A shareholding that was bought back (paragraph 177EA(17)(ga) of the ITAA 1936). This would point away from the requisite purpose.

· Company B only had a small borrowing from a related company, and as such it did not have borrowings from any of the participating shareholders, meaning that none of the off-market share buy-back dividends totalling $V were equivalent to an amount of loan interest received by each of the participating shareholders (paragraph 177EA(17)(h) of the ITAA 1936). This would point away from the requisite purpose.

· Each of the participating shareholders had held each of their ordinary shares in Company B for at least five years (paragraph 177EA(17)(i) of the ITAA 1936). This would point away from the requisite purpose.

· All but one of the participating shareholders (whose ordinary shares were a pre-CGT asset) would have obtained a tax benefit under section 177C of the ITAA 1936 when comparing the effective off-market share buy-back tax rate of 15% to an effective tax rate of 22.5% applied to discount capital gains if those ordinary shares were instead disposed of. However, it is important to note that:

- the purpose of the off-market share buy-back was to remove both X and Y as shareholders, and

- whilst E and F were also removed as shareholders, this related to the earlier Company A off-market share buy-back where the operations of Company A and Company B were separated, as further evidenced by both of these shareholders also ceasing to be directors of Company B.

Therefore when considering the matters referred to in paragraph 177D(b) of the ITAA 1936, none of the participating shareholders entered into the off-market share buy-back for the purpose of enabling them to obtain a tax benefit (paragraph 177EA(17)(j) of the ITAA 1936). This would point away from the requisite purpose.

After considering all of the relevant circumstances, the Commissioner is of the view that section 177EA of the ITAA 1936 does not apply to the off-market share buy-back. This is because it was conducted for the commercial purposes of removing X and Y as shareholders, and also to complete the separation of Company A and Company B by removing E and F as shareholders. Therefore the franking credits paid by Company B to each of the participating shareholders were merely incidental to these commercial purposes.

Question 3

Summary

Company B can debit its franking account in early 2012 by the total $U franking credits as per subsection 205-30(1) of the ITAA 1997.

Detailed reasoning

Subsection 205-15(1) of the ITAA 1997 sets out a table of the vents of when a credit will arise in the franking account of a corporate tax entity, such as a company, and the amount of the credit.

Item 3 of that table provides:

· a credit will occur as a result of the franked distribution (a distribution by a corporate tax entity is defined by subsection 960-120(1) of the ITAA 1997 to include a dividend by a company) being made to Company B, and because it satisfies the residency requirement and is entitled to a tax offset under subsection 207-20(2) of the ITAA 1997

· the credit to Company B's franking account will be the $X franking credits, and

· the $X credit will occur in early 2012, being the date on which the franked dividend was made to Company B.

Subsection 205-30(1) of the ITAA 1997 sets out a table of the events of when a debit will arise in the franking account of a corporate tax entity, such as a company, and the amount of the debit.

Item 1 of that table provides:

· a debit will occur as a result of Company B franking its distributions (a distribution by a corporate tax entity is defined by subsection 960-120(1) of the ITAA 1997 to include a dividend by a company)

· the debit to Company B's franking account will be the total $U on the dividends that are made to each of the participating shareholders, and

· the $U debit will occur in early 2012, being the date on which the dividends are made to each of the participating shareholders.

In conclusion, Company B can debit its franking account in early 2012 by the total $U franking credits as per subsection 205-30(1) of the ITAA 1997. Furthermore, its franking account will be in surplus in accordance with subsection 205-40(1) of the ITAA 1997 at that time.

Question 4

Summary

The Commissioner will determine under subsection 202-75(5) of the ITAA 1997 that Company B may give the off-market share buy-back dividend distribution statements to the participating shareholders before the end of November 2012.

Detailed reasoning

Subsection 202-75(1) of the ITAA 1997 provides that Company B must give the participating shareholders a distribution statement, as the fully franked dividends made by it are frankable distributions as per subsection 202-40(1) of the ITAA 1997,

As Company B meets the definition of private company under subsection 995-1(1) of the ITAA 1997, subsection 202-75(3) of the ITAA 1997 provides that the distribution statements must be given to the participating shareholders before the later of:

· the end of 31 October 2012, or

· the time determined by the Commissioner under subsection 202-75(5) of the ITAA 1997.

Due to the complexity of the off-market share buy-back and the fact that the private ruling application was made before 31 October 2012, the Commissioner accepts that there are reasonable grounds in which to determine a later time.

In conclusion, the Commissioner will determine under subsection 202-75(5) of the ITAA 1997 that Company B may give the off-market share buy-back dividend distribution statements to the participating shareholders before the end of November 2012.