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Edited version of private advice
Authorisation Number: 1012619183845
Ruling
Subject: Share Buyback
Question 1
Will the portion of the Buy-Back Price exceeding the capital component be a dividend for the purposes of section 159GZZZP of the Income Tax Assessment Act 1936 (ITAA 1936)?
Answer
Yes
Question 2
Will that same portion be a frankable distribution for the purposes of section 202-40 of the Income Tax Assessment Act 1997 (ITAA 1997)?
Answer
Yes
This ruling applies for the following periods:
1 July 2013 to 30 June 2014
The scheme commences on:
During the income year ended 30 June 2014
Relevant facts and circumstances
All entities mentioned are residents for Australian tax purposes.
The Company intends to buyback a quantity of ordinary $1 shares out of a number of ordinary $1 shares.
The ordinary shares are the only shares that the Company has on issue and all have the same rights.
The Company is involved with industry.
The Company has cash assets representing the retention of past profits.
The Company is not listed on the Australian Stock Exchange.
The Trust is a discretionary trust.
The Trust is not an advantaged dividend shareholder over the other shareholders in the Company. It does not have tax losses or a tax status that will result it in paying less tax or netting a larger franking credit than the other shareholders in the Company had those other shareholders received the buyback deemed dividend.
The market value of share buyback
The private ruling application states that the share buyback price is a fair market value. This was confirmed in a phone discussion with the tax agent when it was advised that due to the nature of the business it is difficult to obtain a market valuation.
The tax agent advised that the share buyback is an arms-length transaction. Goodwill is likely to be nil as the company is moving into a negative trading pattern
Relevant legislative provisions
Income Tax Assessment Act 1936
section 159GZZZK
paragraph 159GZZZK(a)
paragraph 159GZZZK(b)
paragraph 159GZZZK(d)
section 159GZZZM
paragraph 159ZZZM(a)
section 159GZZZP
subsection 159GZZZP(1)
section 159GZZZQ
Income Tax Assessment Act 1997
202-40
202-45(c)
Reasons for decision
All legislative references are to the ITAA 1936 unless otherwise indicated.
A 'dividend' is defined in subsection 6(1) to include:
(a) any distribution made by a company to any of its shareholders, whether in money or other property; and
(b) any amount credited by a company to any of its shareholders as shareholders.
Subsection 159GZZZP(1) relevantly provides that, for the purposes of the ITAA 1936 and the Income Tax Assessment Act 1997 (ITAA 1997), where a buy-back of a share 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 which is debited against amounts standing to the credit of the company's share capital account,
is taken to be a dividend paid by the company:
(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.
An 'off-market purchase' occurs when a company that is not listed on any official stock exchange buys a share in itself from a shareholder in the company (paragraph 159GZZZK(d)). When the off-market purchase occurs, it is a 'buy-back' and the shareholder is the seller (paragraphs 159GZZZK(a) and (b)).
The purchase price for the purposes of the off-market buy-back provisions is defined in paragraph 159GZZZM(a) to include the amount of money that the seller has received or is entitled to receive as a result of or in respect of the buy-back.
When a shareholder sells their shares to a company in an off-market buy-back, the tax consequences for the shareholder are set out in Subdivision C of Division 16K (sections 159GZZZP and 159GZZZQ of the ITAA 1936).
Accordingly, as the Company is not listed on any official stock exchange, the proposed purchase of the ordinary shares in itself from the Trust is an off-market buy-back and the Trust is the seller. Subject to the operation of subsection 159GZZZQ(2) (discussed below at paragraph 24), the purchase price will be a specified dollar amount.
However, the amount of the purchase price that is treated as a dividend under section 159GZZZP is only the amount that is not debited against the company's share capital account. The amount of the purchase price that is debited against the share capital account is essentially a 'split' between the return of capital and dividend paid to the shareholder.
Section 159GZZZP of the ITAA 1936 specifies when part of the purchase price paid by a company in an off-market buy-back situation is treated as a dividend. It acts to treat the difference between the purchase price and that part of the purchase price (if any) which is debited against a credit in the company's share capital account as a dividend paid by the company to the seller out of profits derived by the company, on the day the buy-back occurs.
Under section 159GZZZP of the ITAA 1936, the purchase price contains a dividend component only if the buy-back price exceeds the amount debited against the company's share capital account.
Subsection 44(1) of the ITAA 1936 provides that dividends paid to you by a company out of profits are included in your assessable income.
The difference between the purchase price and the amount debited against the company's share capital account is taken to be a dividend paid by the company to the Trust.
The provisions of the ITAA 1936 do not prescribe how the company is to allocate the buy-back purchase price against the share capital account. However, the Commissioner will have regard to the various anti-avoidance and integrity rules. The Commissioner considers that there are a number of acceptable methodologies for ascertaining the capital/dividend split, although not all have equal applicability in every case, which are outlined in Law Administration Practice Statement PS LA 2007/9 Share buy-backs (PS LA 2007/9) at paragraph 61.
The applicant advises that due to the nature of the business it is difficult to obtain a market valuation, that the share buyback is an arms-length transaction and that it will be at a fair market value.
Subsection 159GZZZQ(2) provides that if the purchase price in respect of the buy-back is less than what 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, then the amount of the consideration that the seller is taken to have received in respect of the sale of the share is equal to its market value.
It is noted that paragraph 202-45(c) of the ITAA 1997 provides that where the purchase price on the buy-back of a share by a company from one of its members (such as a shareholder) is taken to be a dividend under section 159GZZZP, so much of that purchase price that exceeds the market value of the share is unfrankable.
If the purchase price on the buy-back of the Company shares is above market value, so much of that purchase price that exceeds the market value of the share is unfrankable.