Edited version of private advice

Authorisation Number: 1012645677294

Ruling

Subject: Share Buy Back

Question 1

Will the share buy-back arrangement result in an off-market purchase within the meaning of section 159GZZZK of the Income Tax Assessment Act 1936 (ITAA 1936)?

Answer

Yes

Question 2

a) Will the average capital per share (ACPS) methodology be the most appropriate method of determining the capital and dividend components of the off-market share buy-back purchase price under section 159GZZZP of the ITAA 1936?

b) If so, is the split between the dividend and capital component in accordance with the ACPS methodology?

Answer

(a) Yes

(b) Yes

Question 3

Will the Commissioner apply subsection 159GZZZQ(2) of the ITAA 1936 to deem an increase to the share buy-back purchase price?

Answer

No

Question 4

Will the vendor shareholders be entitled to a tax offset equal to the franking credits attached to the dividend component of the buy-back?

Answer

Yes

Question 5

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

Answer

No

Question 6

Will the Commissioner make determination 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 7

Will the Commissioner make a determination under section 177EA of the ITAA 1936 in relation to the buy-back?

Answer

No

This ruling applies for the following period(s)

Year ended 30 June 2013

Year ended 30 June 2014

The scheme commences on

1 July 2012

Relevant facts and circumstances

The company is a private Australian resident company.

During the year ended 30 June 2013, an off-market share buy-back of all shares held by the vendor shareholders was undertaken.

In accordance with the Share Buy-Back Agreement, the company would buy back the shares for an agreed purchase price payable upon completion of the transaction.

The purchase price will be funded from existing cash reserves.

Subsequent to the completion of the share buy-back, the shares were cancelled.

The share buy-back was carried out in accordance with Division 2 of Part 2J.1 of the Corporations Act 2001. The resolution for the selective buy-back has been lodged with ASIC along with the required statutory forms.

The break-up of the buy-back purchase price between the amount that will be debited to the share capital account (the capital component) and the amount debited to retained earnings (the dividend component) is based on the ATO's preferred ACPS approach in PS LA 2007/9.

The company considers that the buy-back price represented the market value of the shares at the time of the buy-back.

The company does not consider any tainting of their share capital accounts has occurred.

The company issued the vendor shareholders with distribution statements in which the dividend component of the share buy-back is fully franked. The 100% franking of dividends is consistent with dividends paid in the past and in accordance with the benchmarking rules.

Relevant legislative provisions

Income Tax Assessment Act 1936 Section 45A

Income Tax Assessment Act 1936 Section 45B

Income Tax Assessment Act 1936 Section 45C

Income Tax Assessment Act 1936 Section 159GZZZK

Income Tax Assessment Act 1936 Section 159GZZZP

Income Tax Assessment Act 1936 Subsection 159GZZZQ(1)

Income Tax Assessment Act 1936 Subsection 159GZZZQ(2)

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 Section 202-45

Income Tax Assessment Act 1997 Section 207-20

Income Tax Assessment Act 1997 Section 204-30

Income Tax Assessment Act 1997 Subsection 204-30(3)

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

Reasons for decision

Question 1

Will the share buy-back arrangement result in an off-market purchase within the meaning of section 159GZZZK of the ITAA 1936?

Share buy-backs are mainly governed, for taxation purposes, by Division 16K of Part 111 of the ITAA 1936. The Division applies where a company buys a share in itself from a shareholder. On-market and off-market share buy-backs are defined in section 159GZZZK of the ITAA 1936. If the share is listed on a stock exchange and the purchase is made in the ordinary course of business of that stock exchange, the buy-back will be an on-market purchase. All other buy-backs are treated as off-market purchases.

In your case, the share buy-back was carried out in accordance with Division 2 of Part 2J.1 of the Corporations Act 2001. The company is not listed on a stock exchange. Therefore the buy-back is an off-market buy-back in accordance with section 159GZZZK of the ITAA 1936.

Question 2

Will the ACPS methodology be the most appropriate method of determining the capital and dividend components of the off-market share buy-back purchase price under section 159GZZZP of the ITAA 1936? If so, is the split between the dividend and capital component in accordance with the ACPS methodology?

In an off-market buy-back of shares, section 159GZZZP applies to treat the difference between the purchase price and the part of the purchase price which is debited against the company's share capital account as a dividend.

An essential aspect of any off-market share buy-back is the 'split' between the return of capital and dividend paid to participating shareholders. In Law Administration Practice Statement PS LA 2007/9 Share Buy-Backs, the ATO 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 preferred ATO methodology for determining the dividend/capital 'split' is the ACPS method unless companies can demonstrate exceptional circumstances for the use of an alternative methodology. The ACPS is obtained by dividing a company's ordinary issued capital by the number of shares on issue. The amount so derived is a reasonable estimate of any capital component of the split. The balance of any buy-back price would be a dividend.

In the absence of any exceptional circumstances, we consider that the ACPS method that you have used is the most appropriate method and the split between the capital and dividend component has been calculated in accordance with this methodology.

Question 3

Will the Commissioner apply subsection 159GZZZQ(2) of the ITAA 1936 to deem an increase to the share buy-back purchase price?

For the purposes of calculating the amount of gain or loss, the consideration in respect of the disposal of a share under a buy-back is determined in accordance with section 159GZZZQ.

Under subsection 159GZZZQ(1) the shareholder is taken to have received an amount equal to the purchase price as consideration in respect of the sale of the share bought back. However, this amount is subject to certain adjustments in order to arrive at the sale consideration.

Subsection 159GZZZQ(2) is one of the adjusting provisions. It provides that if the purchase price is less than 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, the shareholder is taken to have received an amount equal to the market value as consideration in respect of the sale of the share bought back.

In your case, as the share buy-back price was determined on an arm's length basis, it is accepted that the purchase price is the same as the market value of the shares at the time of the buy-back. Therefore, the Commissioner will not apply subsection 159GZZZQ(2) of the ITAA 1936 to deem an increase to the share buy-back purchase price.

Question 4

Will the vendor shareholders be entitled to a tax offset equal to the franking credits attached to the dividend component of the buy-back?

In accordance with section 202-5 of the ITAA 1997 an entity franks a distribution if:

(a) The entity is a franking entity that satisfies the residency requirement when the distribution is made

(b) The distribution is a frankable distribution and

(c) The entity allocates a franking credit to the distribution.

Paragraph (a) of section 202-5 is satisfied as the company is a franking entity and is an Australian resident at the time of the distribution.

In accordance with section 202-40 of the ITAA 1997, a distribution is a frankable distribution unless they are specified as unfrankable. Section 202-45 of the ITAA 1997 lists the unfrankable distributions.

Paragraph (c) of section 202-45 states that where the purchase price on the buy-back of a share by a company from one of its members is taken to be a dividend under section 159GZZZP, so much of that purchase price as exceeds what would be the market value of the share at the time of the buy-back if the buy-back did not take place and were never proposed to take place.

As the purchase price of the buy-back did not exceed the market value of the shares at the time of the buy-back, paragraph (c) of section 202-45 does not apply.

Paragraph (e) of section 202-45 lists as unfrankable a distribution that is sourced, directly or indirectly, from a company's share capital account. The dividend component of the buy-back is not sourced from the company's share capital account.

Therefore as the dividend distribution is not listed as unfrankable, paragraph (b) of section 202-5 is satisfied as the dividend distribution is a frankable distribution.

Under paragraph (c) of section 202-5, the entity must allocate a franking credit to the distribution. The company has issued distribution statements to the vendor shareholders reflecting a fully franked dividend distribution. Therefore, paragraph (c) of section 202-5 is satisfied.

Section 207-20 of the ITAA 1997 requires the receiving entity (the vendor shareholders), for the income year in which the distribution is made, to include in their assessable income the franking credit on the distribution. The vendor shareholders will be entitled to a tax offset equal to the franking credit attached to the dividend component of the buy-back.

Question 5

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

Section 204-30 of the ITAA 1997 applies where a company streams the payment of franked distributions to its shareholders in such a way that the imputation benefits attaching to the distribution are received by those shareholders who derive a greater benefit from them and other shareholders receive lesser imputation benefits, or no imputation benefits.

If section 204-30 of the ITAA 1997 applies, the Commissioner has a discretion to make one or more determinations pursuant to subsection 204-30(3).

Subsection 204-30(8) of the ITAA 1997 provides a non-exhaustive list of circumstances where a shareholder would be considered to derive a greater benefit from franking credits than another shareholder. Specifically a shareholder will be a 'favoured member' in relation to another shareholder where any of the following circumstances exist for the other shareholder but not the 'favoured member':

• The other shareholder is not an Australian resident

• The other shareholder would not be entitled to any tax offset under Division 207 of the ITAA 1997 because of the distribution;

• The amount of income tax that would be payable by the shareholder because of the distribution is less than the tax offset to which they are entitled;

• The other shareholder is a corporate tax entity at the time the distribution is made but no franking credit arises for that shareholder as a result of the distribution;

• The other shareholder is a corporate tax entity, but cannot use franking credits received on the distribution to frank distributions to its own members because it is not a franking entity or is unable to make frankable distributions; and

• The other shareholder is an exempting entity.

In this case, for section 204-30 to apply, shareholders to whom distributions are made must derive a greater benefit from imputation benefits than the shareholders who do not participate in the share buy-back. The vendor shareholders will be entitled to tax offsets under Division 207 of the ITAA 1997. There are no shareholders who are corporate tax entities, exempting entities or foreign residents. Therefore there are no favoured shareholders who may derive a greater benefit from franking credits.

The Commissioner will not make a determination under subsection 204-30(3) of the ITAA 1997 in relation to the buy-back.

Question 6

Will the Commissioner make determination 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?

Sections 45A and 45B of the ITAA 1936 are two anti-avoidance provisions which, if they apply, allow the Commissioner to make a determination that section 45C of the ITAA 1936 applies.

The effect of such a determination is that all or part of the distribution of capital received by the shareholder under the buy-back is treated as an unfranked dividend. Accordingly, the application of these two provisions to the buy-back must be considered.

Section 45A of the ITAA 1936 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.

Although a 'capital benefit' (as defined in paragraph 45A(3)(b) of the ITAA 1936) is provided to the vendor shareholders under the buy-back, the circumstances of the buy-back indicate that there is no streaming of capital benefits to some shareholders and dividends to other shareholders. Accordingly, section 45A of the ITAA 1936 has no application to the buy-back.

Section 45B of the ITAA 1936 applies where certain capital payments are paid to shareholders in substitution for dividends. In broad terms, section 45B applies where:

(a) there is a scheme under which a person is provided with a capital benefit by a company (paragraph 45B(2)(a) of the ITAA 1936);

(b) under the scheme, a taxpayer, who may or may not be the person provided with the capital benefit, obtains a tax benefit (paragraph 45B(2)(b) of the ITAA 1936); 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 (paragraph 45B(2)(c) of the ITAA 1936).

In this case, the conditions of paragraphs 45B(2)(a) and 45B(2)(b) of the ITAA 1936 have been met as the buy-back constitutes a scheme where the shareholders are provided with a capital benefit which has a tax benefit. Consideration then turns to whether the requisite purpose of enabling the shareholder to obtain a tax benefit by way of capital distribution is present.

According to PS LA 2007/9, to apply section 45B of the ITAA 1936 to a share 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.

A non-exhaustive list of relevant circumstances are found in paragraphs 45B(8)(a) - 45B(8)(k) of the ITAA 1936. Further considerations are listed in paragraphs 177D(b)(i) - 177D(b)(viii) of the ITAA 1936.

In this case, by virtue of the operation of Division 16K in relation to off-market buy-backs, 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. The capital component represents the amount debited to the share capital account of the company.

Having regard to the 'relevant circumstances' of the buy-back, as set out in subsection 45B(8), it is apparent that the inclusion of a capital component as part of the buy-back price was not inappropriate. Further, the capital component of the buy-back cannot be said to be attributable to the profits of the company, nor does the pattern of distributions indicate that the capital component is being paid in substitution for a dividend. Accordingly section 45B has no application to the buy-back.

As sections 45A and 45B have no application, the Commissioner will not make a determination under subsection 45C(3) of the ITAA 1936 in relation to the buy-back.

Question 7

Will the Commissioner make a determination under section 177EA of the ITAA 1936 in relation to the buy-back?

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. 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 a buy-back with a franked dividend component.

Specifically, subsection 177EA(3) provides that section 177EA 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.

In this case the conditions in paragraphs 177EA(3)(a) to (d) of the ITAA 1936 have been satisfied. Accordingly, the issue is whether, having regard to the relevant circumstances of the scheme, it would be concluded that, on the part of the company and the participating shareholders, there is a purpose, which is more than merely an incidental purpose, of obtaining an imputation benefit under the buy-back scheme.

In arriving at a conclusion, 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 circumstances listed in that subsection encompass a range of circumstances which taken individually or collectively indicate the requisite purpose.

Circumstances which may attract the operation of section 177EA of the ITAA 1936 can include:

• the delivery of franking credits in excess of what would have otherwise been distributed in the ordinary course of dividend declaration

• the greater attraction of the buy-back to resident shareholders who could fully utilise the franking credits than to non-resident shareholders who could not

• the greater attraction of the buy-back to some resident shareholders with a low marginal tax rate than other resident shareholders; and

• that participating shareholders were more likely than not to make an economic gain, but a loss for taxation purposes, from their participation.

Having regard to the relevant circumstances of the arrangement as outlined in subsection 177EA(17) of the ITAA 1936 including the fact that none of the vendor shareholders are non-residents, it could not be concluded that there is a purpose which is more than an incidental purpose of obtaining an imputation benefit. Therefore, The Commissioner will not make a determination under section 177EA of the ITAA 1936 in relation to the buy-back.