Edited version of your private ruling

Authorisation Number: 1012512282585

Ruling

Subject: Selective off-market share buy-back

Question 1

Will the taxpayer be taken pursuant to subsection 159GZZZP(1) of the Income Tax Assessment Act 1936 (ITAA 1936) to have received a dividend paid out of profits equal to the dividend component on the day the buy-back occurs?

Answers

Yes

Question 2

Will the Commissioner confirm the methodology adopted to set the buy-back price gives rise to a value which is the best estimate of the market value of the shares at the time of the buy-back such that:

(a) subsection 159GZZZQ of the ITAA 1936 will not apply to deem an increase in the disposal consideration of the shares; and

(b) paragraph 202-45(c) of the Income Tax Assessment Act 1997 (ITAA 1997) will not apply to treat part of the buy-back price as an unfrankable dividend?

Answers

The applicant has withdrawn this question.

As Part F of the publication Market valuation for tax purposes on ato.gov.au explains:

We can provide private, class and product rulings on matters involving valuations. We generally will not rule on the market value for a future event…

We do not usually rule on valuation methods. We can only rule on how a relevant provision applies to a particular taxpayer in relation to a particular scheme, and a question about whether or not a particular method is appropriate may not fall into this category. Moreover, we will often not have sufficient facts to determine the appropriate method to use. In some instances, we may comment on the appropriate method within our explanation of a ruling. This particularly occurs in class or product rulings, where a number of taxpayers are affected.

Question 3

Will the Commissioner 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 part of the capital component?

Answers

No.

Question 4

Will the Commissioner seek to make a determination under section 45B of the ITAA 1936 that section 45C of the ITAA 1936 applies to the whole, or any part, of the share buy-back?

Answers

No.

Question 5

Will section 177EA of the ITAA 1936 have application to the share buy-back proposal where consideration comprises both subscribed capital and franked dividends for a private company?

Answers

No.

Question 6

Will the Commissioner make a determination under paragraph 204-30 of the ITAA 1997 to deny the whole or part of the imputation benefit that would arise in respect to the proposed payment of a fully franked dividend as part of the consideration for the buy-back of shares?

Answers

No.

This ruling applies for the following periods:

1 July 2013 - 30 June 2014

The scheme commences on:

The scheme is expected to commence during the relevant income year.

Relevant facts and circumstances

A Company (ACo) has three equal shareholders, Individual 1, Individual 2 and B Company (BCo)

Each shareholder holds 1 ordinary share and 1,000 B class shares.

The shareholders of ACo are Australian residents for tax purposes.

BCo is a holding company with its only assets being its shares in ACo.

BCo acquired its shares in ACo prior to 20 September 1985.

BCo does not have a net capital loss.

BCo does not have income tax losses.

Proposed share buy-back

A share buy-back is proposed in which ACo will buy back all of BCo's shares in such a way that BCo receives a return of capital for each ordinary and B class share and a dividend on its ordinary share.

ACo has sufficient franking credits to pay a fully franked dividend.

In previous years, ACo has paid some dividends to shareholders but tends to retain profits.

The result of the share buyback on the existing group structure will be to split BCo off from the rest of the group as a company wholly owned by Individual 1 and Individual 2.

Other options to the share buy-back were considered. The applicant advised

The buy-back in its current form was considered the most practical and effective way to achieve the desired separation of and …. Other options were considered…

Amongst these considerations was the sale of assets to a newly incorporated entity this would have achieved the intended complete separation of the businesses. It would have resulted in significant capital gains and stamp duty costs without any change in beneficial ownership rendering this option commercially unfeasible.

The applicant considers that any tax advantages obtained as a result of the share buy-back are merely incidental to the overall aim of the buy-back.

Relevant legislative provisions

Income Tax Assessment Act 1936 159GZZZP,

Income Tax Assessment Act 1936 45A,

Income Tax Assessment Act 1936 45B,

Income Tax Assessment Act 1936 45C,

Income Tax Assessment Act 1936 177EA and

Income Tax Assessment Act 1997 204-30.

Reasons for decision

Question 1

Will the taxpayer be taken pursuant to subsection 159GZZZP(1) of the Income Tax Assessment Act 1936 (ITAA 1936) to have received a dividend paid out of profits equal to the dividend component on the day the buy-back occurs?

Answers

Yes

Subsection 159GZZZP(1) of the ITAA 1936 provides:

Where a buy-back of a share or non-share equity interest by a company is an off-market purchase, the difference between:

(a) the purchase price; and

(b) 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:

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

ii. 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:

(c) to the seller as a shareholder in the company; and

(d) out of profits derived by the company; and

(e) on the day the buy-back occurs.

ACo is buying back its own shares from BCo and then cancelling them.

The difference between the purchase price of the share and that part of the purchase price that is debited against amounts standing to the credit of ACo's share capital account is taken to be a dividend paid by ACo to BCo as a shareholder out of profits derived by ACo on the same day as the buy-back (so falling for assessment under subsection 44(1) of the ITAA 1936).

Accordingly, BCo will be taken to have received a dividend paid by ACo out of profits derived by them on the same day as the share buy-back occurs.

This deemed dividend is a frankable distribution except to the extent (if any) that the purchase price exceeds the market value of the share at the time of the buy-back.

We have not ascertained the market value of the share at the time of the share buy-back as it is a prospective transaction.

As Part F of the publication Market valuation for tax purposes on ato.gov.au explains:

We can provide private, class and product rulings on matters involving valuations. We generally will not rule on the market value for a future event…

Accordingly, we cannot comment as to what extent the deemed dividend is a frankable distribution.

Question 2

Will the Commissioner confirm the methodology adopted to set the buy-back price gives rise to a value which is the best estimate of the market value of the shares at the time of the buy-back such that:

(a) subsection 159GZZZQ of the ITAA 1936 will not apply to deem an increase in the disposal consideration of the shares; and

(b) paragraph 202-45(c) of the Income Tax Assessment Act 1997 (ITAA 1997) will not apply to treat part of the buy-back price as an unfrankable dividend?

Answers

The applicant has withdrawn this question.

As Part F of the publication Market valuation for tax purposes on ato.gov.au explains:

We can provide private, class and product rulings on matters involving valuations. We generally will not rule on the market value for a future event…

We do not usually rule on valuation methods. We can only rule on how a relevant provision applies to a particular taxpayer in relation to a particular scheme, and a question about whether or not a particular method is appropriate may not fall into this category. Moreover, we will often not have sufficient facts to determine the appropriate method to use. In some instances, we may comment on the appropriate method within our explanation of a ruling. This particularly occurs in class or product rulings, where a number of taxpayers are affected.

Question 3

Will the Commissioner 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 part of the capital component?

Answers

No.

Section 45A is an anti-avoidance provision that applies in circumstances where capital benefits are streamed to certain shareholders (the advantaged shareholders) who derive a greater benefit from the receipt of share capital and it is reasonable to assume that the other shareholders (the disadvantaged shareholders) have received or will receive dividends.

Subsection 45A(4) lists some of the circumstances in which a shareholder would, in a year of income, derive a greater benefit from capital benefits than another shareholder. They include:

· some or all of the shares in the company held by the shareholder are, or are taken to be, pre-CGT

BCo's shares in ACo are pre-CGT

· the shareholder is a non-resident

BCo is a resident for tax purposes

· the cost base for the purposes of the CGT provisions is not substantially less than the value of the capital benefit

The proposed capital return is equal to the share capital paid

· the shareholder has a net capital loss in the income year in which the capital benefit is provided

BCo does not have any capital losses

· the shareholder has income tax losses

BCo does not have income tax losses

Although a 'capital benefit' (as defined in paragraph 45A(3)(b)) will be provided to BCo under the share buy-back, the circumstances of the buy-back do not indicate that there is streaming of capital benefits to some shareholders and dividends to other shareholders.

Accordingly, section 45A has no application to the share buy-back and the Commissioner will not make a determination under subsection 45A(2) of the ITAA 1936 that section 45C applies in relation to the capital benefit.

Question 4

Will the Commissioner seek to make a determination under section 45B of the ITAA 1936 that section 45C of the ITAA 1936 applies to the whole, or any part, of the share buy-back made to BCo?

Answers

No.

A purpose of section 45B of the ITAA 1936 is to ensure that 'relevant' amounts paid in substitution for dividends are treated as dividends for income tax purposes (paragraph 45B(1)(b)).

Section 45B applies if the conditions in subsection 45B(2) apply:

a)  there is a scheme under which a person is provided with a capital benefit by a company, and

b)  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, and

c)  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 to obtain a tax benefit.

The phrase provided with a capital benefit is defined in subsection 45B(5) as follows:

A reference to a person being provided with a capital benefit is a reference to any of the following:

(a)  the provision of ownership interests in a company to a person;

(b)  the distribution to the person of share capital or share premium;

(c) something that is done in relation to an ownership interest that has the effect of increasing the value of an ownership interest (which may or may not be the same interest) that is held by the person.

The proposed selective off-market share buy-back of BCo's shares in ACo is a scheme under which there will be a distribution of share capital to BCo, which satisfies the condition in paragraph 45B(2)(a).

The meaning of obtaining a tax benefit is provided in subsection 45B(9) of the ITAA 1936 which states:

A relevant taxpayer obtains a tax benefit if an amount of tax payable, or any other amount payable under this Act, by the relevant taxpayer would, apart from this section, be less than the amount that would have been payable, or would be payable at a later time than it would have been payable, if the demerger benefit had been an assessable dividend or the capital benefit had been an assessable dividend.

As part of the buy-back consideration consists of a distribution of capital on which no tax is payable, BCo would obtain a tax benefit, which satisfies the condition in paragraph 45B(2)(b). 15

The Explanatory Memorandum to Taxation Laws Amendment (Company Law Review) Bill 1998 discusses 'a purpose' as follows:

1.31 New section 45B requires a purpose (whether or not the dominant purpose but not including an incidental purpose) of enabling a taxpayer to obtain a tax benefit. The words in parentheses are inserted for more abundant caution; a reference to a purpose of a scheme is usually understood to include any main or substantial purpose of the scheme, and the words in parentheses clarify that this is the intended meaning here. Thus while new section 45B does not require the purpose of obtaining a tax benefit to be the ruling, most influential or prevailing purpose, neither does it include any purpose which is not a significant purpose of the scheme.

1.32 A purpose is an incidental purpose when it occurs fortuitously or in subordinate conjunction with one of the main or substantial purposes of the scheme, or merely follows that purpose as its natural incident.

Subsection 45B(8) of the ITAA 1936 lists the circumstances that are relevant to determining whether any person has a more than incidental purpose of enabling a person to obtain a tax benefit.

Under the proposed share buy-back, the following are the only factors relevant to the circumstances of the case:

· paragraph 45B(8)(a) - the buy-back price consists of dividend and return of capital components - but as the return of capital corresponds to the capital originally contributed, the capital benefit is not attributable to the profits of the company

· paragraph 45B(8)(b) - ACo had not paid dividends regularly, but the buy-back consideration consists of a franked dividend component that reflects BCo's underlying share of retained profits

· paragraph 45B(8)(d) - the shares to be bought back were acquired by BCo before 20 September 1985. However, this provides no advantage, as the deemed consideration for the shares under section 159GZZZQ of the ITAA 1936 would in any case be reduced to the cost base, so there would be no capital gain or capital loss

· paragraph 45B(8)(h) - BCo's equity interest in ACo would, as a result of the scheme, be eliminated in accordance with the commercial objective of the shareholders

If section 45B applies, the Commissioner may make a determination in writing that section 45C of the ITAA 1936 applies to the whole or part of the capital benefit (paragraph 45B(3)(b)). Section 45C has the effect that the amount of the capital benefit (or part thereof) is taken to be an unfranked dividend paid to the shareholder or relevant taxpayer out of the profits of the company at the time the capital benefit is provided.

After considering all of the relevant circumstances, it cannot reasonably be concluded that there exists the requisite level of purpose of providing a tax benefit to BCo by way of the capital reduction.

Therefore, section 45B of the ITAA 1936 does not apply to deem the return of capital under the proposed share buy-back to be a dividend and the Commissioner will not seek to make a determination under section 45B of the ITAA 1936 that section 45C of the ITAA 1936 applies in whole or in part to the share buy-back made to Geocrete.

Question 5

Will section 177EA of the ITAA 1936 have application to the share buy-back proposal where consideration comprises both subscribed capital and franked dividends for a private company?

Answers

No.

For section 177EA of the ITAA 1936 to apply, all of the conditions in subsection 177EA(3) must be satisfied. The subsection states:

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 the interest in membership interests, as the case may be; and

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

(d) except for this section, the person (the relevant taxpayer) would receive, or could reasonably be expected to receive, imputation benefits as a result of the distribution; and

(e) having regard to the relevant circumstances of the scheme, it would be concluded that the person, or one of the persons, who entered into or carried out the scheme or any part of the scheme did so for a purpose (whether or not the dominant purpose but not including an incidental purpose) of enabling the relevant taxpayer to obtain an imputation benefit.

Under the proposed scheme, paragraph 177EA(3)(a) of the ITAA 1936 is satisfied because there is a scheme for a disposition of membership interests. The proposed buy-back constitutes an arrangement that will affect the legal and equitable ownership interests of the membership interests. The one ordinary share and 1,000 B class shares, which BCo currently holds in ACo, would be cancelled. 10(Individuals 1 and 2 would retain their existing shares, which in theory would be worth the same as before, since they would each own X times the proportion of ACo as they did before, while the buy-back would diminish the value of the company by a similar factor.)

Paragraph 177EA(3)(b) of the ITAA 1936 is satisfied because the distribution to BCo resulting from the buy-back would be a frankable distribution except to the extent (if any) that the purchase price on the buy-back exceeds the market value of the shares (see section 202-40 and paragraph 202-45(c) of the ITAA 1997).

Paragraph 177EA(3)(c) of the ITAA 1936 is satisfied because the distribution under the proposed buy-back is expected to be franked.

Paragraph 177EA(3)(d) of the ITAA 1936 is satisfied because apart from section 177EA of the ITAA 1936, BCo, which is the 'relevant taxpayer' for the purposes of that section, would, or could reasonably be expected to receive imputation benefits (as defined in subsection 204-30(6) of the ITAA 1997) as a result of the distribution (since BCo would be entitled to a tax offset under subsection 207-20(2) of the ITAA 1997, and a franking credit would arise in BCo's franking account under item 3 of the table in subsection 205-15(1) of the ITAA 1997 as a result of the distribution).

Therefore, whether or not section 177EA of the ITAA 1936 applies hinges on whether the condition in paragraph 177EA(3)(e) - the 'purpose' test - is satisfied.

Explaining the meaning of 'incidental purpose' in paragraph 177EA(3)(e) of the ITAA 1936, the EM, at paragraph 8.76 further stated:

8.76 A purpose is an incidental purpose when it occurs fortuitously or in subordinate conjunction with another purpose, or merely follows another purpose as its natural incident.

The High Court, in Mills v Commissioner of Taxation [2012] HCA 51; 2012 ATC 20-360, quoted this passage from the EM at [27] and again at [64], and went on to say (at [64]) that:

The adoption of the meaning conveyed by the statement as the proper construction of the statutory text produces the result that a purpose of a person, in entering into or carrying out the scheme for the disposition of equity interests, of enabling a holder to obtain a franking credit is "an incidental purpose" outside the scope of s 177EA(3)(e) if that purpose does no more than further some other purpose or follow from some other purpose. That result confines the application of s 177EA in a manner that is consistent with its object.

The Court, at [66], added:

… a purpose can be incidental even where it is central to the design of a scheme if that design is directed to the achievement of another purpose. Indeed, the centrality of a purpose to the design of a scheme directed to the achievement of another purpose may be the very thing that gives it a quality of subsidiarity and therefore incidentality. That is not impermissibly to confine the scope of s 177EA(3)(e) to a dominant purpose: the categories of "dominant" and "incidental" are not exhaustive.

and:

… counterfactual analysis is not antithetical to the statutory inquiry mandated by s 177EA(3)(e). Purpose is a matter for inference and incidentality is a matter of degree. Consideration of possible alternatives may well assist the drawing of a conclusion in a particular case that a purpose of enabling a holder to obtain a franking credit does or does not exist and, if such a purpose exists, that the purpose is or is not incidental to some other purpose.

The purpose of the share buy-back, as stated in the private ruling application, is to facilitate the ongoing efficient operation of the business of the group. Currently, BCo is not an operative entity: it is merely a passive holder of shares in ACo, its only significant asset. ACo's activities currently involve a mix of investment activities which have divergent commercial environments, risk profiles and growth expectations. The share buy-back would simultaneously separate BCo from the rest of the group and deliver to it funds.

However, regardless of whether this is the main or dominant purpose of the scheme, paragraph 177EA(3)(e) of the ITAA 1936 directs the Commissioner to consider whether any person who entered into or carried out the scheme did so for a more than incidental purpose of enabling BCo to obtain an imputation benefit (as defined in subsection 204-30(6) of the ITAA 1997). That the buy-back would enable BCo to obtain an imputation benefit is not in doubt: the question is whether (having regard to the 'relevant circumstances' set out in subsection 177EA(17)) the requisite purpose exists.

Our analysis of the relevant circumstances concludes that most of the indicators in subsection 177EA(17) of the ITAA 1936 (including, via paragraph (j) of that subsection, the eight factors in subsection 177D(2) of the ITAA 1936) are either not relevant to the circumstances of the case at hand or clearly do not point to the requisite purpose being present. The remaining factors, numbering four, are those in paragraphs 177EA(17)(b) and (c) of the ITAA 1936 and those in paragraphs 177D(2)(a) and (d) of that Act.

Paragraphs 177EA(17)(b) and (c) state:

(b) whether the relevant taxpayer would, in the year of income in which the distribution is made, or if the distribution flows indirectly to the relevant taxpayer, in the year in which the distribution flows indirectly to the relevant taxpayer, derive a greater benefit from franking credits than other entities who hold membership interests, or have interests in membership interests, in the corporate tax entity;

(c) whether, apart from the scheme, the corporate tax entity would have retained the franking credits or exempting credits or would have used the franking credits or exempting credits to pay a franked distribution to another entity referred to in paragraph (b);

Paragraphs 177D(2)(a) and (d) state:

(a) the manner in which the scheme was entered into or carried out

(d) the result in relation to the operation of this Act that, but for this Part, would be achieved by the scheme

In circumstances where a distribution is made directly to the taxpayer, the note to subsection 177EA(19) of the ITAA 1936 points to subsections 204-30(7), (8), (9) and (10) of the ITAA 1997 for a list of circumstances in which the taxpayer will be treated as deriving a greater benefit from franking credits than another entity for the purposes of paragraph 177EA(17)(b) of the ITAA 1936.

Subsection 204-30(7) of the ITAA 1997 states that subsection 204-30(8) of the ITAA 1997 'lists some of the cases in which a *member of an entity *derives a greater benefit from franking credits than another member of the entity.' It also states that the list is not exhaustive.

Subsection 204-30(8) of the ITAA 1997 states that :

A *member of an entity *derives a greater benefit from franking credits than another member of the entity if any of the following circumstances exist in relation to the other member in the income year in which the distribution giving rise to the benefit is made, and not in relation to the first member:

(a)  the other member is a foreign resident;

(b)  the other member would not be entitled to any *tax offset under Division 207 because of the distribution;

(c)  the amount of income tax that, apart from this Division, would be payable by the other member because of the distribution is less than the tax offset to which the other member would be entitled;

(d)  the other member is a *corporate tax entity at the time the distribution is made, but no *franking credit arises for the entity as a result of the distribution;

(e)  the other member is a *corporate tax entity at the time the distribution is made, but cannot use *franking credits received on the distribution to *frank distributions to its own members because:

(i)  it is not a *franking entity; or

(ii)  it is unable to make *frankable distributions;

(f)  the other member is an *exempting entity

Subsection 204-30(9) of the ITAA 1997 states that:

A *member of an entity *derives a greater benefit from franking credits than another member of the entity if any of the following circumstances exist in relation to the first member in the income year in which the *distribution giving rise to the benefit is made, and not in relation to the other member:

(a)  a *franking credit arises for the first member under item 5, 6 or 7 of the table in section 208-130 (distributions by *exempting entities to exempting entities);

(b)  a franking credit or *exempting credit arises for the first member because the distribution is *franked with an exempting credit;

(c)  the first member is entitled to a *tax offset because:

(i)  the distribution is a *franked distribution made by an exempting entity; or

(ii)  the distribution is *franked with an exempting credit.

Subsection 204-30(10) of the ITAA 1997 states that:

A *member of an entity *derives a greater benefit from franking credits than another member if the first member is entitled a *tax offset under section 210-170 as a result of the *distribution, and the other member is not.

Paragraph 3.42 of the Explanatory Memorandum to New Business Tax System (Imputation) Bill 2002 states that '[a] difference in marginal tax rates of members of a corporate tax entity does not, by itself, indicate that some members derive a greater benefit from imputation credits than others.' However, while paragraph 137 of Law Administration Practice Statement PS LA 2007/9 (about share buy-backs) quotes this paragraph, the third dot point in paragraph 115 of the Practice Statement gives as an example of features that have caused section 177EA of the ITAA 1936 to be applied:

The greater attraction of the buy-back to some resident shareholders with a low marginal tax rate than other resident shareholders (for example, whereas superannuation funds are taxed at 15% and corporations at 30% individuals can be taxed at a marginal tax rate up to 45%).

Relevantly, subsection 204-30(6) of the ITAA 1997 describes what an imputation benefit is, as follows:

A *member of an entity receives an imputation benefit as a result of a distribution if:

(a)  the member is entitled to a *tax offset under Division 207 as a result of the distribution; or

(b)  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; or

(c)  a *franking credit would arise in the *franking account of the member as a result of the distribution; or

(d)  an *exempting credit would arise in the *exempting account of the member as a result of the distribution; or

(e)  the member would not be liable to pay *withholding tax on the distribution, because of the operation of paragraph 128B(3)(ga) of the Income Tax Assessment Act 1936; or

(f)  the member is entitled to a *tax offset under section 210-170 as a result of the distribution.

Section 204-30 of the ITAA 1997 is one of the four so-called anti-streaming provisions within the imputation system (apart from the benchmark rule in section 203-25 of the ITAA 1997). The Explanatory Memorandum to New Business Tax System (Imputation) Bill 2002 states the policy behind the anti-streaming rules at paragraph 3.7 to 3.10:

3.7 To gain a full understanding of the anti-streaming rules it is necessary to understand the underlying policy.

3.8 Where members hold interests in the profits of a corporate tax entity, the policy is that credits for tax paid on behalf of all members should flow to all members and not to only some of them. The franking rules do not, in general, attempt either to track the source of distributed profits or the particular members who hold an interest in a corporate tax entity at any given time. However, the policy of the tax law assumes that the benefit of imputation will, over time, be spread more or less evenly across members in proportion to their holdings in a corporate tax entity, having regard to any particular rights that attach to those holdings.

3.9 A consequence of generally spreading imputation benefits evenly across members is that members who cannot use, or cannot fully use, imputation benefits will nevertheless receive franked distributions. This results in the wastage of those benefits, which is a design feature of the imputation system. Wastage of imputation benefits also includes the failure to use franking credits attributable to profits that are never distributed.

3.10 The benchmark rule and the anti-streaming rules ensure that the intended wastage of imputation benefits is not undermined.

Later, the Explanatory Memorandum, in explaining what streaming is, states:

3.28 Streaming is selectively directing the flow of franked distributions to those members who can most benefit from imputation credits.

3.29 The law uses an essentially objective test for streaming, although purpose may be relevant where future conduct is a relevant consideration. It will normally be apparent on the face of an arrangement that a strategy for streaming is being implemented. The distinguishing of members on the basis of their ability to use franking benefits is a key element of streaming.

3.30 Thus, streaming is unlikely to occur when a corporate tax entity, in making franked distributions, distinguishes between 2 classes of members, both of which comprise members who can and who cannot benefit from imputation credits. However, where one class is predominantly able to use imputation credits, and the other is predominantly not, it may be apparent that an arrangement is streaming, notwithstanding the presence in each class of a small minority of the other type of member.

3.31 Broadly speaking, any strategy directed to defeating the policy of the law by avoiding wastage of imputation benefits through directing the flow of franked distributions to members who can most benefit from them to the exclusion of other members, may amount to streaming.

It is noted in this context that all of the examples in subsections 204-30(8), (9) and (10) of the ITAA 1997 involve schemes that avoid wastage of franking credits, albeit that subsection 204-30(7) of the ITAA 1997 states that the list in subsection 204-30(8) is not exhaustive.

The Explanatory Memorandum, at paragraphs 3.35 - 3.38 further goes on to say:

3.35 It is necessary to distinguish cases where individual members have no effective interest in the profits of a corporate tax entity from the foregoing examples of single distribution streaming.

3.36 In most cases, the members less able to benefit from imputation credits have a real interest in the undistributed profits of the corporate tax entity, although the entity may not have yet allocated those profits to the members. However, some corporate tax entities have membership interests where the rights of the members holding those interests are effectively discretionary, since the entity can make distributions to some members to the exclusion of other members at its discretion. In these entities, which are usually family companies or trusts, the members do not have anything, in a sense relevant for streaming purposes, resembling a definite interest in the profits of the corporate tax entity they have only a possibility of being considered as a possible recipient of distributions.

3.37 In these cases, the receipt of a franked distribution by one class of members does not imply that the other classes of members who have not received a franked distribution have deferred distribution of their share in the profits. More commonly it is reasonable to assume that they have simply missed out on any share in the profits. This is not streaming; all members with an actual share of the profits have appropriately received franked distributions.

3.38 In general, therefore, the distribution of franked and unfranked distributions by a closely-held family company or trust among family members is unlikely to be streaming.

It is clear from the above that the EM and relevant legislation equates streaming with avoiding wastage of franking credits. The proposed share buy-back does not display such a feature. Indeed, even if streaming was indicated, there is no disadvantage to the remaining shareholders of ACo as they are (also) the sole shareholders of BCo.

In summary, it is argued that the relevant circumstance in paragraph 177EA(17)(b) of the ITAA 1936 is not indicative of the requisite purpose and that in paragraph 177EA(17)(c) of the ITAA 1936 is at most ambivalent. In addition, analysis of the relevant factor in paragraph 177D(2)(a) of the ITAA 1936 does not identify any significant relevant issues not considered in the analysis of paragraph 177EA(17)(b) of the ITAA 1936, and the factor in paragraph 177D(2)(d) of the ITAA 1936 merely identifies that there is an imputation benefit without shedding further light on the existence or otherwise of the requisite purpose.

Section 177EA of the ITAA 1936 is an anti-avoidance provision which is designed to prevent improper exploitation of the imputation system. In order to apply it, a mischief must be identified. That is, a reasonable case has to be made that in the circumstances of the scheme, one or more persons who entered into or carried out the scheme did so for a more than incidental purpose of enabling the relevant taxpayer to obtain an imputation benefit. If such a case cannot be made, the benefit otherwise available under the law must be allowed to flow. While the relevant circumstances identified in subsection 177EA(17) provide something of an objective framework for identifying such a mischief, should it be present, it is submitted that in this case, none of these, either singly or in combination, are probative of the ultimate question.

It is submitted that the proposed scheme does not offend against the principles elucidated in paragraphs 8.5 - 8.8 of the Explanatory Memorandum to Taxation Laws Amendment Bill (No. 7) 1997¹ or the specific legislative responses to defend those principles in the form of section 177EA of the ITAA 1936 or the anti-streaming provisions in section 204-30 of the ITAA 1997.

Accordingly, it is concluded that in the present case there is no more than an incidental purpose of enabling BCo to obtain an imputation benefit, and so section 177EA of the ITAA 1936 does not apply.

Question 6

Will the Commissioner make a determination under paragraph 204-30 of the ITAA 1997 to deny the whole or part of the imputation benefit that would arise in respect to the proposed payment of a fully franked dividend as part of the consideration for the buy-back of shares?

Answers

No.

Section 204-30 of the ITAA 1997

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

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

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

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

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

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

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

The terms stream and streaming are not defined in the Act. However, the Explanatory Memorandum to the New Business Tax System (Imputation) Bill 2002 defines streaming as selectively directing the flow of franked distributions to those members who can most benefit from imputation credits.

In addition, at paragraph 3.30 the EM comments on cases where one group has a minor interest: 

Thus, streaming is unlikely to occur when a corporate tax entity in making franked distributions, distinguishes between 2 classes of members, both of which comprise members who can and who cannot benefit from imputation credits. However, where one class is predominantly able to use imputation credits, and the other is predominantly not, it may be apparent that the arrangement is streaming notwithstanding the presence in each class of a small minority of the other type of member.

For section 204-30 to apply, members to whom distributions are streamed must derive a greater benefit from imputation benefits than the members who do not participate in the buy-back. The words 'derives a greater benefit from franking credits' (imputation benefits) are defined in subsection 204-30(8) by reference to the ability of the members to fully utilise imputation benefits.

The Commissioner holds the view that the structure of an off-market buy-back is a means whereby franking credits may be streamed to resident shareholders, who will receive a greater benefit from franking credits than non-residents.

All shareholders in ACo are Australian residents for tax purposes and are equally able to benefit from imputation credits.

There is no evidence of dividend streaming in the proposed buy-back arrangement and consequently the Commissioner will not make a determination under section 204-30 of the ITAA 1997 to deny the whole or part of the imputation benefit that will arise in respect of the proposed payment of a fully franked dividend as part of the consideration for the buy-back of shares.

¹ 8.5 Two of the underlying principles of the imputation system are, firstly, that the benefits of imputation should only be available to the true economic owners of shares, and only to the extent that those taxpayers are able to use the franking credits themselves and, secondly, that tax paid at the company level is in broad terms imputed to shareholders proportionately to their shareholdings.

8.6 Franking credit trading schemes allow franking credits to be inappropriately transferred by, for example, allowing the full value of franking credits to be accessed without bearing the economic risk of holding the shares. These schemes undermine the first principle.

8.7 Companies can also engage in dividend streaming (i.e. the distribution of franking credits to select shareholders), which undermines the second principle by attributing tax paid on behalf of all shareholders to only some of them. Generally this entails the streaming of franking credits to taxable residents and away from non-residents and tax-exempts.

8.8 The Bill introduces a general anti-avoidance rule and anti-streaming measures to restore these underlying principles of the imputation system.