Edited version of your written advice

Authorisation Number: 1051332929580

Date of advice: 31 January 2018

Ruling

Subject: Off-market share buy-back

Question 1

Will the Commissioner confirm that Division 16K of Part III of the Income Tax Assessment Act 1936 (ITAA 1936) will apply to the share buy-back?

Answer

Yes

Question 2

Will the portion of the Purchase Price exceeding the Capital Component, which is debited to the Company’s retained earnings account, be a dividend for the purposes of section 159GZZZP of the ITAA 1936?

Answer

Yes

Question 3

Will the Dividend Component be a frankable distribution under section 202-40 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes

Question 4

Will the Commissioner conclude that section 177EA of the ITAA 1936 applies to the share buy-back scheme?

Answer

No

Question 5

Will the Commissioner conclude that section 204-30 of the Income Tax Assessment Act 1997 (ITAA 1997) applies to the share buy-back scheme?

Answer

No

Question 6

Will the share buy-back scheme give rise to a direct value shift under Division 725 of the ITAA 1997?

Answer

No

Question 7

Will the share buy-back scheme give rise to an indirect value shift under Division 727 of the ITAA 1997?

Answer

No

Question 8

Will the Company’s benchmark franking percentage be 50% for the income year ending 30 June XXXX for the purposes of Division 203 of the ITAA 1997?

Answer

No

This ruling applies for the following period(s)

201X-XX income year

201X-XX income year

The scheme commences on

During the year ended XXXX

Relevant facts and circumstances

The Company is an Australian resident for tax purposes.

The shareholders of the Company (the Company shareholders) include resident and non-resident individuals and other resident entities.

Selective Share buy-back Agreement

A Selective Share buy-back Agreement (the Agreement) was executed between the Company, a resident individual and a resident entity (the Participating Shareholders).

The purpose of the buy-back was to offer the Participating Shareholders a means to exit the Company.

The Participating Shareholders each agreed to sell and the Company agreed to purchase the Buy-back Shares held by the Participating Shareholders in accordance with the terms of the Agreement.

The buy-back was subject to and conditional on the approval of the Company Shareholders in accordance with section 257D of the Corporations Act.

The Commissioner accepts the purchase price as being acceptable for taxation purposes.

The purchase price comprised a dividend component (Dividend Component) and capital component (Capital Component).

The purchase price was paid to the Participating Shareholders in two tranches into nominated bank accounts.

The Average Cost Per Share method (ACPS method) was used to determine the Capital Component and Dividend Component of the purchase price.

The Capital Component was debited to share capital.

The Dividend Component was debited to retained earnings.

The Company franked the Dividend Component of the Participating Shareholders’ purchase price at 50% and had sufficient franking credits to frank the Dividend Component to that extent.

Upon completion of the sale and purchase of the Buy-back Shares contemplated by the Agreement, legal and beneficial ownership in those shares passed to the Company.

The Company cancelled the Buy-back Shares.

Other

The Company has not previously undertaken a share buy-back in the past.

The Company has a history of paying franked dividends to the Company Shareholders.

The Company has only one class of ordinary share on issue.

The Participating Shareholders held their shares in the Company for a significant period of time prior to the buy-back.

Relevant legislative provisions

Income Tax Assessment Act 1936 Division 16K

Income Tax Assessment Act 1936 section 159GZZZJ

Income Tax Assessment Act 1936 paragraph 159GZZZK(a)

Income Tax Assessment Act 1936 section 159GZZZN

Income Tax Assessment Act 1936 subsection 159GZZP(1)

Income Tax Assessment Act 1936 subsection 177A(1)

Income Tax Assessment Act 1936 section 177EA

Income Tax Assessment Act 1936 subsection 177EA(3)

Income Tax Assessment Act 1936 paragraph 177EA(3)(a)

Income Tax Assessment Act 1936 paragraph 177EA(3)(b)

Income Tax Assessment Act 1936 paragraph 177EA(3)(c)

Income Tax Assessment Act 1936 paragraph 177EA(3)(d)

Income Tax Assessment Act 1936 paragraph 177EA(3)(e)

Income Tax Assessment Act 1936 subsection 177EA(5)

Income Tax Assessment Act 1936 subsection 177EA(14)

Income Tax Assessment Act 1936 subsection 177EA(17)

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)(d)

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)(i)

Income Tax Assessment Act 1936 paragraph 177EA(17)(j)

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 203-5

Income Tax Assessment Act 1997 section 203-25

Income Tax Assessment Act 1997 section 204-30

Income Tax Assessment Act 1997 subsection 204-30(1)

Income Tax Assessment Act 1997 subsection 204-30(2)

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 Division 207

Income Tax Assessment Act 1997 subsection 725-145(1)

Income Tax Assessment Act 1997 subsection 725-145(2)

Income Tax Assessment Act 1997 subsection 725-145(3)

Income Tax Assessment Act 1997 subsection 727-5(1)

Income Tax Assessment Act 1997 section 960-120

Reasons for decision

Question 1

Division 16K of the ITAA 1936 contains the rules for the tax treatment of share buy-backs and applies where a company buys a share in itself from a shareholder and cancels the share.

Under paragraph 159GZZK(a) of the ITAA 1936, a buy-back involves a company purchasing shares in itself from a shareholder of the company. Where the shares are not listed on an official stock exchange, the buy-back is an off-market buy back under paragraph 159GZZZK(c) of the ITAA 1936.

As the Company is buying shares in itself from the Participating Shareholders and cancelling them under the Agreement, the purchase would constitute a buy-back and the buy-back is one to which Division 16K applies. As the shares are not listed on an official stock exchange, the buy-back is an off-market buy-back.

Under section 159GZZZN of the ITAA 1936, where a company buys-back a share, the buy-back and any subsequent cancellation of the share is disregarded when determining whether an amount is included in the company’s assessable income, an amount is an allowable to deduction to the company or in determining whether the company makes a capital gain or capital loss.

In accordance with section 159GZZZN of the ITAA 1936, the buy-back and the cancellation will be disregarded in determining the Company’s assessable income, deductions, capital gains and capital losses.

Question 2

In an off-market share buy-back, the difference between the purchase price and any part of the purchase price in respect of the buy-back of the share debited against amounts standing to the credit of the share capital account is taken to be a dividend paid out of profits by the company to the shareholder on the day the buy-back occurs under subsection 159GZZP(1) of the ITAA 1936.

Practice Statement Law Administration PS LA 2007/9 Share buy-backs (PS LA 2007/9) provides the methodologies available to calculate the split between dividend and capital split, including the ACPS method. This method requires a company’s ordinary issued capital to be divided by the number of shares on issue to give a reasonable estimation of the capital component of a purchase price with any amount in excess reflecting the dividend component.

The Company used the ACPS method to reasonably estimate the dividend/capital split. The amount of the purchase price that exceeded the amount debited to the share capital account will be taken to be a dividend paid out of profits by the Company on the day of the buy-back under subsection 159GZZP(1) of the ITAA 1936.

Question 3

A distribution for the purposes of the Act is a dividend or something that is deemed to be a dividend under the Act as stated in section 960-120 of the ITAA 1997.

Under subsection 202-40(1) of the ITAA 1997, a distribution is a frankable distribution to the extent it is not unfrankable under section 202-45 of the ITAA 1997.

The Dividend Component is a distribution for the purposes of the Act.

Question 4

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.

Subsection 177EA(3) of the ITAA 1936 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.

Scheme for a disposition of member interests in a corporate tax entity

A scheme is defined in subsection 177A(1) of the ITAA 1936 as:

(a) any agreement, arrangement, understanding, promise or undertaking, whether express or implied and whether or not enforceable, or intended to be enforceable, by legal proceedings; and

(b) any scheme, plan, proposal, action, course of action or course of conduct.

Subsection 177EA(14) defines a ‘scheme for a disposition of membership interests’. A scheme for a disposition of membership interests would include an off-market share buy-back arrangement.

The Company is a corporate tax entity. As the off-market share buy-back of the Company’s shares constitutes a scheme for a disposition, paragraph 177EA(3)(a) of the ITAA 1936 is satisfied.

Frankable distribution has been paid to a person in respect of the membership interest

As each Participating Shareholder received a frankable distribution in respect of the Buy-back Shares, paragraph 177EA(3)(b) of the ITAA 1936 is satisfied.

The distribution was a franked distribution

A distribution is a franked distribution if it is franked in accordance with section 202-5 of the ITAA 1997. Specifically, section 202-5 of the ITAA 1997 requires:

● the entity to be a franking entity and a resident at the time of the distribution

● the distribution to be a frankable distribution; and

● the entity to allocate franking credits to the distribution.

The Company paid a Dividend Component to each of the Participating Shareholders under the Agreement. The Dividend Component constitutes a distribution. The Company is also a franking entity by virtue of being a corporate tax entity and was a resident at the time of the distribution. The Company allocated franking credits to the Dividend Component.

The Dividend Component was a franked distribution and, as such, paragraph 177EA(3)(c) of the ITAA 1936 is satisfied.

The relevant taxpayer would receive imputation benefits except for section 177EA

The relevant taxpayers in this case are the Participating Shareholders.

Situations in which a relevant taxpayer would directly receive an imputation benefit as a result of a distribution are detailed in subsection 204-30(6) of the ITAA 1997 and include:

● where a shareholder is entitled to the franking credit offset under Division 207 of the ITAA 1997 (paragraph 204-30(6)(a) of the ITAA 1997); and

● an amount of franking credit included in the assessable income of a trust provided that trust is not a corporate tax entity or a complying superannuation entity (paragraph 204-30(6)(b) and section 204-35 of the ITAA 1997).

As the Participating Shareholders received imputation benefits as a result of the distribution, paragraph 177EA(3)(d) of the ITAA 1936 is satisfied.

There was a more than incidental purpose of enabling the relevant taxpayer to obtain an imputation benefit

Subsection 177EA(17) of the ITAA 1936 provides the relevant circumstances of a scheme that need to be considered in determining whether there was a more than incidental purpose of enabling a relevant taxpayer to obtain an imputation benefit.

The relevant circumstances listed in subsection 177EA(17) of the ITAA 1936 encompass a range of circumstances, which taken individually or collectively, could indicate the requisite purposes. Due to the diverse nature of the circumstances, some may or may not be present at any one time in relation to a particular scheme.

The relevant circumstances as they apply in this case are:

● the Participating Shareholders held the risks of loss and the opportunities for profit or gain the entire time they held shares in the Company. There is no evidence suggesting that anything was done to mitigate or alter the risks the Participating Shareholders were exposed to for the duration they held shares in the Company (paragraph 177EA(17)(a) of the ITAA 1997)

● as the shareholders of the Company include non-residents who cannot benefit from the franking credit offset, the Participating Shareholders would have derived a greater benefit from the franking credits attached to the Dividend Component than other shareholders in the income year in which the distribution was made as per subsection 204-30(8) of the ITAA 1936 (paragraph 177EA(17)(b) of the ITAA 1997)

● if the off-market share buy-back had not occurred, the Company would have made franked distributions directly to the Company Shareholders in line with its existing dividend policy (paragraphs 177EA(17)(c) and (d) of the ITAA 1997)

● there is no consideration paid by the Participating Shareholders under the Agreement that represents the value of franking (paragraph 177EA(17)(f) of the ITAA 1997)

● there is no evidence to support a conclusion that a deduction is allowable or a capital loss is incurred in connection with the Dividend Component under the scheme (paragraph 177EA(17)(g) of the ITAA 1997)

● the Dividend Component is not sourced from unrealised or untaxed profits (paragraph 177EA(17)(ga) of the ITAA 1997)

● both Participating Shareholders held shares in the Company for an extended period of time (paragraph 177EA(17)(i) of the ITAA 1997)

● no steps undertaken as part of the off-market share buy-back suggest contrivance or artificiality, there is no disparity between the substance of the scheme and its form and there are no obvious timing advantages under the scheme (paragraph 177EA(17)(j) of the ITAA 1997); and

● the only entities whose financial position has changed under the off-market share buy-back is the Company who has less share capital and the Participating Shareholders whose financial position has changed due to the desire to exit the Company (paragraph 177EA(17)(j) of the ITAA 1997).

After consideration of the relevant circumstances, the Commissioner concludes that the provision of imputation benefits to the Participating Shareholders was incidental to the off-market share buy-back.

The Commissioner therefore concludes that the Company and the Participating Shareholders did not enter into the Arrangement for a more than incidental purpose of enabling the Participating Shareholders to obtain an imputation benefit.

The Commissioner will therefore not make a determination under subsection 177EA(5) of the ITAA 1997.

Question 5

Subdivision 204-D of the ITAA 1997 aims to prevent the streaming of imputation benefits to one member of a corporate tax entity in preference to another. Subsection 204-30(1) of the ITAA 1997 states:

This section empowers the Commissioner to make determinations if an entity streams one or more *distributions (or one or more distributions and the giving of other benefits), whether in a single *franking period or in a number of franking periods, 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; and

(b) the member would *derive a *greater benefit from franking credits than another member of the entity; 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.

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.

A distribution is defined in subsection 960-120 of the ITAA 1997 as a dividend or something taken to be a dividend under the Act.

Where the above is present, the Commissioner can make a determination to either debit the franking account of the entity or that no imputation benefit is to arise in relation to the distribution made to the favoured member under subsection 204-30(3) of the ITAA 1997.

An imputation benefit is (relevantly) received as a result of a distribution where a member:

● is entitled to a tax offset under Division 207 of the ITAA 1997 (paragraph 204-30(6)(a) of the ITAA 1997); or

● includes an amount in assessable income as a result of the distribution by virtue of section 207-35 of the ITAA 1936 (paragraph 204-30(6)(b) of the ITAA 1997).

A favoured member receives a greater benefit from franking credits than another member pursuant to subsection 204-30(8) of the ITAA 1997 where, for example:

● the other member is a foreign resident (paragraph 204-30(8)(a) of the ITAA 1997); and

● the other member is not entitled to a tax offset under Division 207 because of the distribution (paragraph 204-30(8)(b) of the ITAA 1997).

However, subsection 204-30(7) of the ITAA 1997 states the above list should not be considered as exhaustive.

The term “streaming” is not defined in the Act. Streaming of distributions is roundly thought of as selectively directing the flow of franked distributions to those members who can most benefit from imputation benefits as stated in paragraph 3.28 of Explanatory Memorandum to the New Business Tax System (Imputation) Bill 2002.

Under the Agreement, the Participating Shareholders were provided with an imputation benefit as a result of the Dividend Component paid in relation to the buy-back of their shares. As both the Participating Shareholders were residents, they would have received a greater benefit from franking credits than other Company shareholders, most of which were non-residents. The other resident and non-resident Company shareholders did not receive any imputation benefits.

The Commissioner points to the fact that the Company shareholders that did not participate in the Agreement included resident and non-resident entities and that the Company only has one class of share on issue.

What occurred under the Agreement does not constitute streaming of distributions to favoured shareholders. The imputation benefit provided to the Participating Shareholders was merely incidental to the exit of those shareholders from the Company.

The Commissioner concludes that section 204-30 of the ITAA 1997 does not apply and therefore no determination as provided under subsection 204-30(3) of the ITAA 1997 will be made.

Question 6

Subsection 725-145(1) of the ITAA 1997 states:

There is a direct value shift under a scheme involving equity or loan interests in an entity (the target entity) if:

(a) there is a decrease in the market value of one or more equity or loan interests in the target entity; and

(b) the decrease is reasonably attributable to one or more things done under the scheme, and occurs at or after the time when that thing, or the first of those things is done; and

(c) either or both of subsections (2) and (3) are satisfied.

Subsection 725-145(2) of the ITAA 1997 states:

One or more equity or loan interests in the target entity must be issued at a discount. The issue must be, or must reasonably be attributable to, the thing, or one or more of the things, referred to in paragraph 1(b). It must also occur at or after the time referred to in that paragraph.

Subsection 725-145(3) of the ITAA states:

Or, there must be an increase in the market value of one or more equity or loan interests in the target entity. The increase must be reasonably attributable to the thing, or to one or more of the things, referred to in paragraph (1)(b). It must also occur at or after the time referred to in that paragraph.

PS LA 2007/9 states that there may be a direct value shift in the context of a share buy-back where the buy-back is part of a broader capital restructure and consideration should also be given to the existence of any direct value shift prior to the share buy-back. Conducting an off-market share buy-back at a discount or premium may give rise to direct value shifting consequences.

The Commissioner concludes that the off-market share buy-back did not give rise to a direct value shift.

Question 7

An indirect value shift arises where there is a net shift of value from one entity to another as stated in subsection 727-5(1) of the ITAA 1997. The general premise involves a reduction in the value of equity or loan interests in one entity and a corresponding increase in the value of interests in another entity.

PS LA 2007/9 states that there may be an indirect value shift in the context of a buy-back where the buy-back is part of a broader capital restructure and consideration should also be given to the existence of any direct value shift prior to the share buy-back. An indirect value shift may also occur as a consequence of a direct value shift from a share buy-back.

The Commissioner concludes that the off-market share buy-back did not give rise to an indirect value shift.

Question 8

The benchmark rule requires a corporate tax entity to frank all frankable distributions made within a particular period at a franking percentage set as the benchmark for that period as detailed in sections 203-5 and 203-25 of the ITAA 1997.

The benchmark franking percentage is set by reference to the franking percentage for the first frankable distribution made by an entity during the relevant period. The relevant period is called the ‘franking period’ and for a private company, the franking period for an income year is the income year.

The benchmark rule does not apply where subsection 203-20(1) of the ITAA 1997 is met. However, that subsection cannot be satisfied where the entity is a private company.

The Company’s benchmark franking percentage for the 20XX-XX income year was set at 50%.

The Company was committed and liable to pay the Dividend Component in the 20XX-XX income year. The Company can reset its benchmark franking percentage for the current income year.