Edited version of your written advice

Authorisation Number: 1051490185140

Date of advice: 15 April 2019

Ruling

Subject: Income tax - Return of capital – Share buy-back

Question 1

Will section 159GZZZN of the Income Tax Assessment Act 1936 (ITAA 1936) apply to Company A such that the Off-Market Share Buy-Back (the Buy-Back) and any subsequent cancellation of the ordinary shares in Company A (Company A Shares) will be disregarded for the purposes of determining whether:

a) an amount is included in the assessable income of Company A under the Income Tax Assessment Act 1997 (ITAA 1997) or ITAA 1936

b) an amount is allowable as a deduction to Company A, or

c) an amount of a capital gain or capital loss arises to Company A?

Answer

Yes.

Question 2

Will Company A be taken to have paid Company A shareholders who participate in the Buy-Back (Participating Shareholders) a dividend out of profits derived by it on the day the Buy-Back occurs equal to the Dividend Component pursuant to subsection 159GZZZP(1) of the ITAA 1936?

Answer

Yes.

Question 3

Under subsection 159GZZZP(1) of the ITAA 1936, is the date of the Buy-Back the day the Buy-Back agreement is entered into?

Answer

Yes.

Question 4

Will the Dividend Component paid to the Participating Shareholders constitute a frankable distribution for the purposes of subsection 202-40(1) of the ITAA 1997?

Answer

Yes.

Question 5

Will paragraphs 202-45(a) through to 202-45(j) of the ITAA 1997 apply to treat all or part of the Buy-Back Price as an unfrankable distribution?

Answer

No.

Question 6

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 a part, of the Capital Component?

Answer

No.

Question 7

Will the Commissioner make a determination under subsection 45B(3) of the ITAA 1936 that section 45C applies in relation to the whole, or a part, of the Capital Component?

Answer

No.

Question 8

(a) Will the Commissioner exercise his discretion to make a determination under paragraph 177EA (5)(a) of the ITAA 1936, which Company A will accept, that a franking debit will arise in the franking account of Company A in respect of franked dividends paid – being the Dividend Component of the Buy-Back Price – as part of the Buy-Back?

(b) Will the Commissioner make a determination under paragraph 177EA (5)(a) of the ITAA 1936, which Company A will accept, that a franking debit will arise in the franking account of Company A in respect of franked dividends paid as part of the Buy-Back, calculated in accordance with the following formula?

Number of shares bought back

X

Franking credit attaching to each share bought back

X

% of non-resident shareholders of Company A in tax treaty nations

X

0.5

Answer

(a) Yes.

(b) Yes.

Question 9

Will the Commissioner make a determination under paragraph 204-30(3)(a) of the ITAA 1997 that a specified franking debit arises in Company A’s franking account in respect of the whole, or a part of the Dividend Component?

Answer

No.

Question 10

Will the Commissioner make a determination under paragraph 177EA(5)(a) of the ITAA 1936 that a franking debit arises in Company A’s franking account in respect of the Final Ordinary Dividend?

Answer

No.

Question 11

Will the Commissioner make a determination under paragraph 204-30(3)(a) of the ITAA 1997 that a franking debit arises in Company A’s franking account in respect of the Final Ordinary Dividend?

Answer

No.

Question 12

For the purpose of determining whether Company A has a withholding obligation under section 12-210 of Schedule 1 to the Taxation Administration Act 1953 (TAA 1953) in respect of the Final Ordinary Dividend, will the Commissioner make a determination under either paragraph 177EA(5)(b) of the ITAA 1936 or paragraph 204-30(3)(c) of the ITAA 1997 in respect of the dividend?

Answer

No.

This ruling applies for the following period:

Income tax year ended 31 December 20xx in lieu of 30 June 20xx

The scheme commences on:

During the income tax year ended 31 December 20xx.

Relevant facts and circumstances

1. Company A is an Australian resident with a mix of shareholders being individuals, companies and superannuation funds, some of whom are non-residents.

2. Company A will undertake a Buy-Back of its ordinary shares with all shares bought back under the Buy-Back cancelled.

3. Company A would not buy back any shares at a price higher than the deemed market value determined in accordance with Taxation Determination TD 2004/22: Income tax: for Off-Market Share Buy-Backs of listed shares, whether the buy-back price is set by tender process or not, what is the market value of the share for the purposes of subsection 159GZZZQ(2) of the Income Tax Assessment Act 1936? (TD 2004/22) and PS LA 2007/9, taking into account any ‘ex-dividend’ adjustment.

4. The Buy-Back Price consisted of a Dividend Component and a Capital Component.

5. The Dividend Component of the Buy-Back Price was debited against Company A’s retained earnings. The Dividend Component was equal to the Buy-Back Price less the Capital Component. The Dividend Component was fully franked.

6. The Capital Component of the Buy-Back Price was debited against Company A’s untainted share capital account.

7. Company A also paid a franked dividend to its shareholders.

Relevant legislative provisions

Income Tax Assessment Act 1936 Section 45A

Income Tax Assessment Act 1936 Subsection 45A(2)

Income Tax Assessment Act 1936 Paragraph 45A(3)(b)

Income Tax Assessment Act 1936 Section 45B

Income Tax Assessment Act 1936 Paragraph 45B(2)(a)

Income Tax Assessment Act 1936 Paragraph 45B(2)(b)

Income Tax Assessment Act 1936 Paragraph 45B(2)(c)

Income Tax Assessment Act 1936 Paragraph 45B(3)(b)

Income Tax Assessment Act 1936 Paragraph 45B(5)(b)

Income Tax Assessment Act 1936 Subsection 45B(8)

Income Tax Assessment Act 1936 Subsection 45B(9)

Income Tax Assessment Act 1936 Section 45C

Income Tax Assessment Act 1936 Paragraph 128B(3)(ga)

Income Tax Assessment Act 1936 Paragraph 159GZZZK(a)

Income Tax Assessment Act 1936 Section 159GZZZN

Income Tax Assessment Act 1936 Subsection 159GZZZP(1)

Income Tax Assessment Act 1936 Section 177D(2)

Income Tax Assessment Act 1936 Section 177EA

Income Tax Assessment Act 1936 Subsection 177EA(3)

Income Tax Assessment Act 1936 Subsection 177EA(5)

Income Tax Assessment Act 1936 Paragraph 177EA(5)(a)

Income Tax Assessment Act 1936 Paragraph 177EA(5)(b)

Income Tax Assessment Act 1936 Paragraph 177EA(14)(b)

Income Tax Assessment Act 1936 Paragraph 177EA(14)(d)

Income Tax Assessment Act 1936 Subsection 177EA(16)

Income Tax Assessment Act 1936 Subsection 177EA(17)

Income Tax Assessment Act 1936 Subsection 177EA(18)

Income Tax Assessment Act 1936 Subsection 177EA(19)

Income Tax Assessment Act 1997 Section 202-5

Income Tax Assessment Act 1997 Section 202-40

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

Income Tax Assessment Act 1997 Section 202-45

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

Income Tax Assessment Act 1997 Section 204-15

Income Tax Assessment Act 1997 Section 204-30

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

Income Tax Assessment Act 1997 Paragraph 204-30(1)(a)

Income Tax Assessment Act 1997 Paragraph 204-30(1)(b)

Income Tax Assessment Act 1997 Paragraph 204-30(1)(c)

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

Income Tax Assessment Act 1997 Paragraph 204-30(3)(a)

Income Tax Assessment Act 1997 Subsection 204-30(6)

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

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

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

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

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

Income Tax Assessment Act 1997 Subsection 204-30(9)

Income Tax Assessment Act 1997 Subsection 204-30(10)

Income Tax Assessment Act 1997 Division 207

Income Tax Assessment Act 1997 Section 960-120

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

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

Taxation Administration Act 1953 Section 12-210 of Schedule 1

Taxation Administration Act 1953 Section 12-310 of Schedule 1

Reasons for decision

Question 1

Summary

Section 159GZZZN will apply to Company A such that the Buy-Back and any subsequent cancellation of the Company A Shares will be disregarded for the purposes listed in the section.

Detailed reasoning

Under section 159GZZZN, where a company buys-back a share then the buy-back, and any subsequent cancellation of the share, are disregarded for the purposes of:

(a) determining for the purposes of this Act:

(i) whether an amount is included in the assessable income of the company under a provision of this Act (other than a provision of Part 3-1 or 3-3 of the Income Tax Assessment Act 1997 (about CGT)); or

(ii) whether an amount is allowable as a deduction to the company; or

(b) determining whether the company makes a capital gain or capital loss.

Under the Buy-Back, Company A will buy-back Company A Shares within the meaning given by paragraph 159GZZZK(a). Pursuant to subsection 257H(3) of the Corporations Act 2001, immediately after the registration of the transfer to Company A of Company A Shares purchased under a buy-back, the Company A Shares are cancelled. Accordingly, the Buy-Back and the subsequent cancellation of Company A Shares will be disregarded for the purposes listed in section 159GZZZN. That is, for the purposes of determining whether Company A:

– includes an amount in its assessable income under a provision of the ITAA 1936 or the ITAA 1997 (other than a provision of Part 3-1 or 3-3 (about CGT))

– is entitled to a deduction for an amount under the ITAA 1936 or the ITAA 1997, and

– makes a capital gain or capital loss under Part 3-1 or 3-3.

Question 2

Summary

Under subsection 159GZZZP(1), for each share bought back under the Buy-Back, the difference between the Buy-Back Price and the Capital Component of the Buy-Back Price will be taken to be a dividend paid by Company A out of profits it derived for the purposes of the ITAA 1936 and ITAA 1997.

Detailed reasoning

Deemed dividend

Subsection 159GZZZP(1) applies to the Buy-Back.

In the context of the Buy-Back, subsection 159GZZZP(1) will operate to treat the difference between:

● the Buy-Back Price, and

● the part of the Buy-Back Price which is debited against amounts standing to the credit of Company A’s share capital account,

to be a dividend (the Dividend Component) paid by Company A.

The Dividend Component is also taken under subsection 159GZZZP(1) to be paid to Participating Shareholders as shareholders in Company A, out of profits it derived, and on the day the Buy-Back occurs.

For each share bought back under the Buy-Back, Company A will debit the Capital Component against the amount standing to the credit of its untainted share capital account. As a result, under subsection 159GZZZP(1), for each share Company A purchases under the Buy-Back, the difference between:

● the Buy-Back Price, and

● the Capital Component,

will be taken to be a dividend paid by Company A out of profits derived by Company A for the purposes of the ITAA 1936 and the ITAA 1997.

Question 3

Summary

Under subsection 159GZZZP(1), the date of the Buy-Back is the day the Buy-Back agreement was entered into.

Detailed reasoning

Subsection 159GZZZP(1) provides that a specified part of the purchase price of an off-market buy-back is deemed to be a dividend paid by the company ‘on the day the buy-back occurs’.

The Commissioner considers that the time the buy-back occurs for the purposes of the subsection is anytime on the day that the entities enter into the Buy-Back agreement.

Question 4

Summary

The entire Dividend Component of the Buy-Back Price will be a frankable distribution within the meaning given by subsection 202-40(1).

Detailed reasoning

Frankable distribution

The Dividend Component will constitute a ‘distribution’ within the meaning given by item 1 of the table in subsection 960-120(1) as:

… a dividend, or something that is taken to be a dividend, under this Act.

A distribution is a frankable distribution to the extent that it is not unfrankable under section 202-45 (subsection 202-40(1)).

As set out in the Detailed reasoning for Question 5 below, no part of the Dividend Component will constitute an unfrankable Dividend.

Therefore, the entire Dividend Component will constitute a frankable distribution for the purposes of subsection 202-40(1).

Question 5

Summary

Paragraphs 202-45(a) through to 202-45(j) will not apply to treat any part of the Dividend Component as an unfrankable distribution.

Detailed reasoning

Section 202-45 provides a list of distributions that are unfrankable as follows:

…

(c) 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 of that Act - so much of that purchase price as exceeds what would be the market value (as normally understood) 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;

(d) a distribution in respect of a *non-equity share;

(e) a distribution that is sourced, directly or indirectly, from a company's *share capital account;

(f) an amount that is taken to be an unfrankable distribution under section 215-10 (certain dividends paid by authorised deposit-taking institutions) or 215-15 (certain non-share dividends);

(g) an amount that is taken to be a dividend for any purpose under any of the following provisions:

(i) unless subsection 109RB(6) or 109RC(2) applies in relation to the amount - Division 7A of Part III of that Act (distributions to entities connected with a *private company);

…

(iii) section 109 of that Act (excessive payments to shareholders, directors and associates);

(iv) section 47A of that Act (distribution benefits - CFCs);

(h) an amount that is taken to be an unfranked dividend for any purpose:

(i) under section 45 of that Act (streaming bonus shares and unfranked dividends);

(ii) because of a determination of the Commissioner under section 45C of that Act (streaming dividends and capital benefits);

(i) a *demerger dividend;

(j) a distribution that section 152-125 or 220-105 says is unfrankable.

Paragraphs 202-45 (a) and (b) have been repealed.

Paragraph 202-45(c) is relevant to off-market share buy-backs, and provides that part of the Dividend Component is unfrankable to the extent that the Buy-Back Price of a share exceeds the share’s relevant ‘market value’. Company A will conduct the Buy-Back at a discount to market value and has provided an undertaking not to buy back a share for an amount that is greater than the market value of a Company A share calculated in accordance with TD 2004/22 and the methodology set out in Example 7 of Appendix A to PS LA 2007/9. As a result, paragraph 202-45(c) will not operate to treat any part of the Dividend Component as an unfrankable dividend.

None of the other paragraphs of section 202-45 apply to treat some or all of the Dividend Component of the Buy-Back Price as an unfrankable distribution for the purposes of subsection 202-40(1).

Question 6

Summary

The Commissioner will not make a determination under subsection 45A(2) that section 45C applies to the whole, or a part, of the Capital Component of the Buy-Back Price.

Detailed reasoning

Section 45A is an anti-avoidance rule that applies where a company:

● streams ‘capital benefits’ to shareholders who derive a greater benefit from the receipt of share capital (advantaged shareholders), and

● it is reasonable to assume that other shareholders (disadvantaged shareholders) have received or will receive dividends.

Participating Shareholders will be provided with a capital benefit – being the Capital Component of the Buy-Back Price – under the Buy-Back in the form of a distribution of share capital (paragraph 45A(3)(b)).

Although a capital benefit will be provided to Participating Shareholders under the Buy-Back, the circumstances of the Buy-Back indicate that there is no particular streaming of capital benefits to some shareholders and dividends to other shareholders. In particular:

● the Buy-Back is in substance an ‘equal access scheme’, and participation is available to all shareholders registered on the Record Date (except for Excluded Shareholders)

● the decision whether or not to participate in the Buy-Back is at the discretion of each Shareholder

● each Participating Shareholder will receive the same Dividend Component and Capital Component per share bought back

● shareholders who do not participate in the Buy-Back will not receive any other dividend or distribution as compensation for not participating in the Buy-Back, and

● both Participating Shareholders and non-Participating Shareholders will, to the extent that they remain shareholders, continue to be eligible to receive ordinary dividends on an equal basis.

Accordingly, the Commissioner will not make a determination under subsection 45A(2) that section 45C applies to the whole, or a part, of the Capital Component of the Buy-Back Price.

Question 7

Summary

The Commissioner will not make a determination under paragraph 45B(3)(b) that section 45C applies to the whole, or a part, of the Capital Component of the Buy-Back Price.

Detailed reasoning

Section 45B applies where:

● there is a scheme under which a person is provided with a capital benefit by a company (paragraph 45B(2)(a))

● 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 (paragraph 45B(2)(b)), and

● 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 (the relevant taxpayer) to obtain a tax benefit (paragraph 45B(2)(c)).

The Buy-Back constitutes a ‘scheme’ within the meaning given by subsection 995-1(1). As set out above in the Detailed reasoning for Question 6 above, Participating Shareholders will be ‘provided with a capital benefit’ under the Buy-Back in the form of a distribution of share capital (paragraph 45B(5)(b)). As a result, the requirements of paragraph 45B(2)(a) is satisfied in respect of the Buy-Back.

Broadly, a Participating Shareholder ‘obtains a tax benefit’ under the Buy-Back if the amount of tax payable by a Participating Shareholder in respect of the Capital Component of the Buy-Back Price would be less than the amount of tax that would instead be payable if the Capital Component were instead an assessable dividend (subsection 45B(9)).

Whether a Participating Shareholder would obtain a tax benefit in respect of the Capital Component of the Buy-Back Price per share requires consideration of each Participating Shareholder’s particular circumstances on a case by case basis. Company A Shares are held by a wide variety of shareholders. Given that the Company A Shares have traded at no less than $X since 1 April 20xx and generally at higher amounts, it is likely that many Participating Shareholders will obtain a tax benefit under the Buy-Back and the requirements of paragraph 45B(2)(b) will in turn be satisfied.

Paragraph 45B(2)(c) provides that one must have regard to the ‘relevant circumstance’ of the Buy-Back to determine whether Company A or a Participating Shareholder entered into or carried out the Buy-Back for a more-than-incidental-purpose of enabling one or more Participating Shareholders to obtain a tax benefit.

The relevant circumstances to be considered are not exhaustively listed in subsection 45B(8) and include any of the matters set out in subsection 178D(2).

Following a consideration of the relevant circumstances of the Buy-Back, neither Company A nor a Participating Shareholder will enter into or carry out the Buy-Back for the requisite purpose of enabling a Participating Shareholder to obtain a tax benefit. In particular:

● the Dividend and Capital Components of the Buy-Back Price are acceptable in Company A’s circumstances and in particular adopt the Commissioner’s preferred ACPS method as set out in PS LA 2007/9

● Company A’s dividend history and policy indicate that the Capital Component of the Buy-Back Price is not a substitute for ordinary dividends

● Company A has a strong history of paying fully-franked ordinary dividends, which will be unaffected by the Buy-Back, and

● the Buy-Back will result in a reduction in the number of Company A Shares held by Participating Shareholders.

The tax benefit, if any, that may arise for a Participating Shareholder is incidental to the main or substantial purpose of the Buy-Back, being to efficiently distribute surplus capital to shareholders because of its strong balance sheet and cash flows position.

Therefore, section 45B will not apply to the Buy-Back. Accordingly, the Commissioner will not make a determination under paragraph 45B(3)(b) that section 45C applies to the whole, or a part of the capital benefit provided under the Buy-Back.

Question 8

Summary

(a) The Commissioner will make a determination under paragraph 177EA(5)(a) that a franking debit arises in the franking account of Company A, which Company A will accept, in respect of franked dividends paid as the Dividend Component part of the Buy-Back Price.

(b) The above mentioned franking debit will be calculated in accordance with the following formula:

Number of shares bought back

x

Franking Credit attaching to each share bought back

x

% non-residents in tax treaty nations

x

0.5

Detailed reasoning

Section 177EA is a general anti-avoidance provision that applies to franking credit trading schemes where one of the purposes (other than an incidental purpose) of the schemes is to obtain a franking credit benefit. The provision 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 which includes an off-market share buy-back with a franked dividend component.

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 membership interests, as the case may be; and

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

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

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

For section 177EA to apply, the five specific conditions set out in paragraphs 177EA(3)(a) to (e) must each be present (conjunctive). For the Buy-Back, the conditions of paragraphs 177EA(3)(a) to (d) will be satisfied as follows:

(a) Company A will satisfy paragraph 177EA(3)(a) as there is a scheme for disposition of membership interests as defined in paragraphs 177EA(14)(b) and (d) as under the Buy-Back, Company A will enter into a contract (or transactions) that affects the ownership of Company A Shares held and disposed by Participating Shareholders which will then subsequently be cancelled.

(b) Paragraph 177EA(3)(b) will also be satisfied as a frankable distribution will be paid as part of the Buy-Back Price pursuant to section 202-40, noting the distributions will not be unfrankable as set out in the Detailed reasoning for Question 4 and Question 5.

(c) Paragraph 177EA(3)(c) will be satisfied as, pursuant to section 995-1, a franked distribution arises if the distribution is franked in accordance with section 202-5. The Dividend Component will be fully franked.

(d) Paragraph 177EA(3)(d) will be satisfied as Participating Shareholders will receive an imputation benefit as per the Note to subsection 177EA(16) and as defined in subsection 204-30(6). For present purposes, Participating Shareholders will be members who are entitled to tax offsets under Division 207 (paragraph 204-30(6)(a)).

Paragraph 177EA(3)(e) requires a conclusion that Company A, its Participating Shareholders or any other relevant party entered into the Buy-Back with a more-than-incidental-purpose of enabling the Participating Shareholders (each a relevant taxpayer) to obtain an imputation benefit. In arriving at a conclusion as to purpose under paragraph 177EA(3)(e), the Commissioner must have regard to the relevant circumstances of the arrangement which are not exhaustively outlined in subsection 177EA(17).

The most relevant circumstance for the proposed Buy-Back is its greater attraction to resident shareholders who could fully utilise the franking credits than to non-resident shareholders. Paragraph 177EA(17)(b) states:

(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;

The meaning of the phrase ‘given greater benefit from franking credits’ is further and not exhaustively set out in subsections 177EA(18) and (19). For direct distributions such as those which will be received by the Participating Shareholders, the Note following subsection 177EA(19) refers to subsections 204-30(7) to (10).

Subsection 204-30(8) lists circumstances that apply for Company A’s Participating Shareholders. Paragraph 204-30(8)(a) looks to the greater attraction of the imputation benefits attached to the Dividend Component of the Buy-Back Price to (certain) resident Participating Shareholders than for non-resident shareholders.

As treaty non-residents hold a percentage of Company A shares, the Commissioner concludes that the terms and conditions of the Buy-Back were unattractive to the non-resident shareholders.

Paragraphs 177EA(17)(c), (d), (g) and (j) are also relevant to the Buy-Back. These paragraphs state:

…

(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);

(d) whether, apart from the scheme, a franked distribution would have flowed indirectly to another entity referred to in paragraph (b);

…

(g) whether a deduction is allowable or a capital loss is incurred in connection with a distribution that is made or that flows indirectly under the scheme;

…

(j) any of the matters referred to in subsection 177D(2).

…

For the purposes of paragraph 177EA(17)(c), Company A has a history of distributing fully franked dividends to its shareholders. Regardless of the Buy-Back, Company A intends to continue to make franked distributions to shareholders.

Accordingly, with or without the Buy-Back, that portion of franking credits would be used in paying franked distributions to its shareholders, but the portion which would be used for the Buy-Back would otherwise be retained by Company A.

For the purposes of paragraph 177EA(17)(d), any increased, fully franked dividends that Company A would otherwise pay to its shareholders in the absence of the Buy-Back may flow directly or indirectly to another entity subject to paragraph 17EA(17(b).

For the purposes of paragraph 177(17)(g), the Sale Consideration of the Capital Component per share as adjusted by the operation of subsection 159GZZZQ(2) is less than the trading price of Company A Shares. Therefore, the Buy-Back Price will most likely result in Participating Shareholders making capital losses or being entitled to allowable deductions.

Finally, as referred in paragraph 177EA(17)(j), the matters outlined in subsection 177D(2) also requires consideration. However, as observed in Mills v Federal Commissioner of Taxation 2011 ATC 20-247 at 131, many of the matters referred to in subsection 177D(2) have no application beyond the extent to which those circumstances have already been taken into account for the other circumstances in subsection 177EA(17).

In relation to the Buy-Back, the Commissioner considers that the matters raised by paragraph 177EA(17)(j) have already been taken into account in the discussion above.

Having regard to all the relevant circumstances of the Buy-Back discussed above but with particular weight attributed to paragraph 177EA(17)(b), the Commissioner is of the view that section 177EA applies to the Buy-Back.

Where section 177EA applies, the Commissioner has a discretion pursuant to subsection 177EA(5) to make a determination to debit the company’s franking account under paragraph 177EA(5)(a), or to deny the imputation benefit arising to each Participating Shareholder under paragraph 177EA(5)(b).

The Commissioner’s practice is to apply paragraph 177EA(5)(a) where a buy-back price achieved does not achieve a discount greater than the maximum acceptable level of discount of 14% of the VWAP of the Company A Shares for the five days up to and including the Closing Date of the buy-back.

Company A has provided an undertaking not to purchase Company A Shares under the Buy-Back at a discount greater than 14% of the VWAP of the Company A Shares for the five days leading up to and including the Closing Date of the Buy-Back. As a result, the Commissioner will exercise his discretion in such a way as to debit Company A’s franking account pursuant to subsection 177EA(5)(a).

Company A has indicated that it would accept such a franking debit and that the franking debit ought to be calculated in accordance with PS LA 2007/9.

The Commissioner will calculate the franking debit to Company A’s franking account using the following formula:

Number of shares bought back

x

Franking Credit attaching to each share bought back

x

% non-residents in tax treaty nations

x

0.5

The Franking credit attaching to each Company A Share will be calculated as follows:

(Buy-Back Price – the Capital Component) x 30/70 and is truncated to the nearest cent.

Question 9

The Commissioner will not make a determination under paragraph 204-30(3)(a) that a specified franking debit arises in Company A’s franking account in respect of the whole, or a part of the Dividend Component.

Detailed reasoning

Subsection 204-30(1) empowers the Commissioner to make a determination if a corporate tax entity streams one or more distributions (or one or more distributions and the giving of other benefits), to its members in such a way that:

(a) an ‘imputation benefit’ is, or apart from section 204-30 of the ITAA 1997 would be, received by a member of the entity as a result of the distribution or distributions

(b) the member would derive a ‘greater benefit from the 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.

If the conditions in subsection 204-30(1) are met, the Commissioner may make a determination under paragraph 204-30(3)(a) that a franking debit arises in the franking account of the entity for a specified distribution or other benefit to a disadvantaged member.

The requirements of subsection 204-30(1) are satisfied in respect of the Buy-Back because:

● Participating Shareholders will receive an imputation benefit (within the meaning given by subsection 204-30(6)) as a result of receiving the fully franked Dividend Component of the Buy-Back Price

● Some Participating Shareholders will derive a greater benefit from franking credits than other Company A shareholders (for example, non-resident Company A shareholders – see subsections 204-30(7) and 204-30(8)), and

● It is reasonable to conclude that the features of the Buy-Back will influence some non-resident Company A shareholders not to participate in the Buy-Back, and as a result not receive any imputation benefits in respect of the Buy-Back.

Accordingly, the conditions in subsection 204-30(1) are met and the Commissioner could make a determination under paragraph 204-30(3)(a) that a franking debit arises in the franking account of Company A for a specified distribution or other benefit to a disadvantaged Company A shareholder.

However, paragraph 142 of PS LA 2007/9 states that the Commissioner will generally not make a determination pursuant to subsection 204-30(3) in cases where he intends exercising his discretion under section 177EA.

As the Commissioner intends to exercise his discretion under paragraph 177EA(5)(a) such that a franking debit will arise in the franking account of Company A in respect of the franked dividends as part of the Buy-Back, the Commissioner will not make a determination under paragraph 204-30(3)(a).

Question 10

Summary

The Commissioner will not make a determination under paragraph 177EA(5)(a) that a franking debit arises in Company A’s franking account in respect of the Final Ordinary Dividend.

Detailed reasoning

An explanation of subsection 177EA(3) is set out above in the Detailed reasoning for Question 8.

For section 177EA to apply, the five specific conditions set out in paragraphs 177EA(3)(a) to (e) must each be present (conjunctive).

The Final Ordinary Dividend will be paid to all Company A shareholders that hold shares on the Record Date.

For the Final Ordinary Dividend, the paragraph 177EA(3)(a) requirement will not be satisfied as it will not be paid as part of a scheme for disposition of membership interests as defined in paragraphs 177EA(14)(b) and (d).

As one of the conjunctive requirements of subsection 177EA(3) does not apply for the Final Ordinary Dividend, section 177EA cannot apply and therefore the Commissioner will not make a determination under paragraph 177EA(5)(a) that a franking debit arises in Company A’s franking account for the Final Ordinary Dividend.

Question 11

Summary

The Commissioner will not make a determination under paragraph 204-30(3)(a) that a franking debit arises in Company A’s franking account in respect of the Final Ordinary Dividend.

Detailed reasoning

An explanation of subsection 204-30(1) is set out in the Detailed reasoning for Question 9.

The Final Ordinary Dividend will be paid relevantly to all Company A shareholders that hold Company A Shares on the Record Date.

‘Streaming’ is not defined for the purposes of section 204-30. However, the Commissioner considers that it refers to a company ‘selectively directing the flow of franked distributions to those members who can most benefit from the imputation credits’ (paragraph 3.28 of the Explanatory Memorandum to the New Business Tax System (Imputation) Bill 2002).

For section 204-30 to apply, members to whom distributions are streamed must derive a greater benefit from franking credits than another member of the entity. The words ‘derive a greater benefit from franking credits’ are defined in subsection 204-30(8) by reference to the ability of the members to fully utilise imputation benefits.

Under the current arrangement, all shareholders will receive an imputation benefit when the Final Ordinary Dividend is paid. The imputation benefit for resident shareholders is in the form of a tax offset (paragraph 204-30(6)(a)), and for non-resident shareholders is in the form of not being liable to pay dividend withholding tax (paragraph 204-30(6)(e)). The resident shareholders may derive a greater benefit from franking credits than the non-resident shareholders.

However, the Final Ordinary Dividend will be paid equally to all Company A shareholders and will be fully franked regardless of their tax profiles.

The Commissioner accepts that Company A has not selectively directed the flow of franked, Final Ordinary Dividend distributions to those members who could most benefit from the franking credits.

As the conditions in subsection 204-30(1) will not be met, the Commissioner will not make a determination under paragraph 204-30(3)(a) that a franking debit arises in Company A’s franking account.

Question 12

Summary

For the purpose of determining whether Company A has a withholding obligation under section 12-210 of Schedule 1 to the TAA 1953 in respect of the Final Ordinary Dividend, the Commissioner will not make a determination under either paragraph 177EA(5)(b) or paragraph 204-30(3)(c) in respect of the dividend.

Detailed reasoning

Dividend withholding obligations under the TAA 1953

Section 12-210 of Schedule 1 to the TAA 1953 provides that a company that is an Australian resident must withhold an amount from a dividend it pays if:

(a) according to the register of the company’s members, the entity, or any of the entities, holding the *shares on which the dividend is paid has an address outside Australia; or

(b) that entity, or any of those entities, has authorised or directed the company to pay the dividend to an entity or entities at a place outside Australia.

For limits on the amount to be withheld, see section 12-300.

Company A advised that the shareholders in Company A are a mix of individuals, companies and superannuation funds, some of whom are non-residents. A percentage of Company A’s shares are held by non-resident shareholders that reside in jurisdictions that Australia has a double tax agreement with.

Section 12-300 of Schedule 1 to the TAA 1953 provides limits on the amount to be withheld as follows:

This Subdivision does not require an entity:

(a) to withhold an amount from a *dividend, from interest (within the meaning of Division 11A of Part III of the Income Tax Assessment Act 1936) or from a *royalty if no *withholding tax is payable in respect of the dividend, interest or royalty; or

(b) to withhold from a dividend, from interest (within the meaning of that Division) or from a royalty more than the withholding tax payable in respect of the dividend, interest or royalty (reduced by each amount already withheld from it under this Subdivision).

Note: Section 128B of the Income Tax Assessment Act 1936 deals with withholding tax liability.

Under paragraph 128B(3)(ga), liability to withholding tax does not apply to:

… income that consists of:

(i) the franked part of a dividend; or

(ii) in relation to a dividend that is paid by a former exempting entity (within the meaning of the Income Tax Assessment Act 1997) on a share acquired under an employee share scheme (within the meaning of that Act) - the part of the dividend that is franked with an exempting credit; or

(iii) in relation to a dividend that is paid by a former exempting entity (within the meaning of the Income Tax Assessment Act 1997) to an eligible continuing substantial member (within the meaning of that Act) - the part of the dividend that is franked with an exempting credit;

other than a dividend in respect of which a determination is made under paragraph 204-30(3)(c) of the Income Tax Assessment Act 1997 or a dividend or a part of a dividend in respect of which a determination is made under paragraph 177EA(5)(b) of this Act; or …

As discussed in the Detailed reasoning for Question 10 and for Question 11 above, neither section 204-30 nor section 177EA applies to the Final Ordinary Dividend. Accordingly, the Commissioner will not make a determination under paragraph 204-30(3)(c) or a determination under paragraph 177EA(5)(b) that no imputation benefit is to arise in respect of the Final Ordinary Dividend to a non-resident shareholder.

Therefore, due to the operation of paragraph 128B(3)(ga), section 12-300 of Schedule 1 to the TAA 1953 will not apply to require Company A to withhold an amount on the Final Ordinary Dividend. This is because withholding tax is not payable on the Final Ordinary Dividend that Company A will pay to a non-resident shareholder as the Final Ordinary Dividend will be fully franked.