Edited version of private advice

Authorisation Number: 1051782959216

Date of advice: 26 November 2020

Ruling

Subject: Off-market share buy-back

Question 1

Does the Buy-Back constitute an off-market share buy-back for the purposes of Division 16K of the Income Tax Assessment Act 1936 (ITAA 1936)?

Answer

Yes.

Question 2

Will section 202-45 of the Income Tax Assessment Act 1997 (ITAA 1997) apply to treat any part of the Dividend Component as an unfrankable dividend?

Answer

No.

Question 3

Will the Commissioner make a determination under subsection 177EA(5) of the ITAA 1936 that section 177EA applies to the whole, or any part, of the Dividend Component of the Buy-Back Price?

Answer

No.

Question 4

Will the Commissioner make a determination under subsection 204-30(3) of the ITAA97 that section 204-30 applies to the whole, or any part, of the Dividend Component of the Buy-Back Price?

Answer

No.

Question 5

Will the Commissioner make a determination under section 45A or section 45B that section 45C of the ITAA 1936 applies to the whole, or any part, of the Capital Component of the Buy-Back Price?

Answer

No.

This ruling applies for the following period:

Income year ended 30 June 20xx

The scheme commences on:

1 July 20xx

Relevant facts and circumstances

This ruling is based on the facts stated in the description of the scheme that is set out below. If your circumstances are materially different from these facts, this ruling has no effect and you cannot rely on it. The fact sheet has more information about relying on your private ruling.

The Company proposes to buy-back ordinary shares in accordance with the share buy-back requirements in the Corporations Act 2001, which includes cancelling the shares after completion of the buy-back (Buy-Back).

The Company will pay the Buy-Back Price as consideration for the shares. The valuation undertaken as part of the proposed share buy-back will be consistent with ATO guidance and processes (https://www.ato.gov.au/General/Capital-gains-tax/In-detail/Market-valuations/Market-valuation-for-tax-purposes/) for establishing market value for tax purposes.

The Capital Component will be debited against the Company's Contributed Equity account.

The difference between the Buy-Back Price and the Capital Component will be taken to be a dividend (Dividend Component).

As the Dividend Component is paid in the income year ended 30 June 2021, the Shareholder will include this amount in its assessable income for the income year ended 30 June 20xx.

The Company has a consistent history of distributing fully franked dividends to shareholders. It is intended that the Company will continue to distribute franked dividends to Shareholders.

The Company's share capital account has not been tainted for tax purposes in accordance with Division 197 of the ITAA 1997.

The Company and Shareholders are all Australian tax residents.

Relevant legislative provisions

Income Tax Assessment Act 1936 Division 16K

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 section 159GZZZQ

Income Tax Assessment Act 1936 subsection 177A(1)

Income Tax Assessment Act 1936 subsection 177D(2)

Income Tax Assessment Act 1936 section 177EA

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 204-30

Income Tax Assessment Act 1997 Division 207

Income Tax Assessment Act 1997 section 207-35

Income Tax Assessment Act 1997 subsection 975-300(1)

Reasons for Decision

Question 1

Summary

The share buy-back arrangement constitutes an off-market share buy-back within the meaning of Division 16K of the ITAA 1936.

Detailed reasoning

Broadly, Division 16K of the ITAA 1936 outlines the income tax consequences of share buy-backs. This division applies where a company buys a share in itself from its shareholders and as a result cancels the share. Accordingly, Division 16K should apply in the context of the proposed Buy-Back.

Section 159GZZZK of the ITAA 1936 provides that share buy-backs take the form of an on-market purchase or an off-market purchase. In accordance with paragraph 159GZZZK(d) of the ITAA 1936 the share buy-back will be an off-market purchase where it is not an on-market purchase. Paragraph 159GZZZK(c) of the ITAA 1936 provides that an on-market purchase will arise if:

      i.        the share is listed for quotation in the official list of a stock exchange in Australia or elsewhere; and

     ii.        the buy-back is made in the ordinary course of trading on that stock exchange.

The Company is not listed for quotation on the official list of a stock exchange in Australia or elsewhere, the Buy-Back cannot be made in the ordinary course of trading on that stock exchange. Therefore, in accordance with paragraph 159GZZZK(d) of the ITAA 1936, the proposed Buy-Back will constitute an off-market purchase for the purpose of Division 16K of the ITAA 1936.

Application of Division 16K of the ITAA 1936

Section 159GZZZP of the ITAA 1936 provides that where the buy-back of a share is an off-market purchase, the difference between the purchase price and the part (if any) of the purchase price which is debited against the share capital account, is taken to be a dividend paid by the company to the seller on the day the buy-back occurs.

A company's 'share capital account' is defined in subsection 975-300(1) of the ITAA 1997 as an account that the company keeps of its share capital or any other account, whether or not called a share capital account, created on or after 1 July 1998, where the first amount credited to the account was an amount of share capital.

With respect to the Company the Contributed Equity account represents a share capital account for income tax purposes on the basis that the first amount credited to that account was an amount of share capital (arising from the issue of an ordinary share).

The Commissioner considers that the proposed methodology to determine the dividend/capital split under the Buy-Back is acceptable.

Therefore, the purchase price (Buy-Back Price) will be $xx per share and $xx per share will be debited against the Company's Contributed Equity account, being a share capital account (the Capital Component).

Accordingly, the difference between the Buy-Back Price and the Capital Component will be taken to be a dividend, being the Dividend Component in accordance with subsection 159GZZZP(1) of the ITAA 1936.

The Dividend Component will be taken to be a dividend paid by the Company the Shareholder, out of profits derived by the Company on the day of the buy-back under subsection 159GZZP(1) of the ITAA 1936. Accordingly, the Dividend Component will be included in the assessable income of the Shareholder in the year of income in which the Buy-Back occurs.

Adjustments to the consideration under the buy-back

Subsection 159GZZZQ(1) of the ITAA 1936 provides that a 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 deemed consideration.

Subsection 159GZZZQ(2) of the ITAA 1936 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 (calculated as 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.

The methodology to determine the market value of the Company's shares at the time of the Buy-Back is consistent with ATO guidance and processes.

Due to this, it is considered that the Buy-Back price is equal to the market value of the shares at the time of the Buy-Back.

Accordingly, subsection 159GZZZQ(2) of the ITAA 1936 will not apply as the Buy-Back Price is equal to market value of each Buy-Back share at the time of the Buy-Back as if the Buy-Back did not occur and was never proposed to occur.

A further adjustment will apply to the deemed consideration provided under the Buy-Back is under subsection 159GZZZQ(3) of the ITAA 1936 where the deemed consideration received upon disposal of the Company X shares under the Buy-Back is reduced by a 'reduction amount'.

The reduction amount is an amount calculated under subsection 159GZZZQ(4) of the ITAA 1936 and requires a taxpayer to determine the part of the purchase price that is treated as a dividend by section 159GZZZP of the ITAA 1936 and is either included in the shareholder seller's assessable income or is an eligible non-capital amount.

In this case, the Dividend Component will be $xx per share in accordance with section 159GZZZP of the ITAA 1936. The Dividend Component will be included in the assessable income of the Shareholder in the year of income in which the Company's Contributed Equity account is debited.

Accordingly, it is considered that the reduction amount is $xx per share.

Where the seller is a corporate tax entity, additional modifications to the reduction amount may be applicable in subsections 159GZZZQ(8) and 159GZZZQ(9) of the ITAA 1936.

In this case, subsections 159GZZZQ(8) and 159GZZZQ(9) of the ITAA 1936 will not apply to adjust the consideration received under the Buy-Back.

Question 2

Summary

Section 202-45 of the ITAA 1997 will not apply to treat any part of the Dividend Component as an unfrankable dividend.

Detailed reasoning

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.

Section 202-45 of the ITAA 1997 provides a number of instances in which distributions are unfrankable distributions. Paragraph 202-45(c) is relevant to off-market share buy-backs.

Under paragraph 202-45(c) of the ITAA 1997, the Dividend Component is frankable but only to the extent that the Buy-Back Price does not exceed the market value of each Buy-Back share at the time of the Buy-Back if the Buy-back did not occur and was never proposed to occur.

The methodology to determine the market value of the Company's shares at the time of the Buy-Back is consistent with ATO guidance and processes. Therefore, it is considered that the Buy-Back Price does not exceed the market value of each Buy-Back share at the time of the buy-back if the buy-back did not occur and was never proposed to occur.

Accordingly, paragraph 202-45(c) of the ITAA 1997 will not apply 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).

As a result, the Dividend Component will be a frankable distribution under section 202-40 of the ITAA 1997 and therefore, capable of being franked in accordance with section 202-5 of the ITAA 1997.

Question 3

Summary

The Commissioner will not make a determination under paragraph 177EA(5)(a) of the ITAA 1936 that a franking debit arises in respect of the Buy-Back.

Detailed reasoning

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. Broadly, 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 includes a buy-back with a franked dividend component.

Specifically, subsection 177EA(3) of the ITAA 1936 provides that section 177EA of the ITAA 1936 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.

Based on the facts, it is considered that the conditions of paragraphs 177EA(3)(a) to 177EA(3)(d) of the ITAA 1936 are satisfied because:

¢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

¢a Shareholder will receive a frankable distribution in respect of the Buy-back shares, paragraph 177EA(3)(b) of the ITAA 1936 is satisfied

¢as the Dividend Component is expected to be a franked distribution to the extent of the available franking credits, paragraph 177EA(3)(c) of the ITAA 1936 is satisfied, and

¢a Shareholder will receive imputation benefits as a result of the distribution, paragraph 177EA(3)(d) of the ITAA 1936 is satisfied.

The question is therefore whether, having regard to the relevant circumstances of the scheme, it would be concluded that, on the part of the Company, its shareholders or any other relevant party, there is a more than an incidental purpose of conferring an imputation benefit under the scheme. Under this arrangement, the relevant taxpayer is Shareholder Y and the scheme comprises the circumstances surrounding the Buy-Back.

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.

Conclusion

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

The Commissioner therefore concludes that the Company and Shareholder did not enter into the Buy-Back for a more than incidental purpose of enabling the Shareholder to obtain an imputation benefit.

The Commissioner will therefore not make a determination under subsection 177EA(5) of the ITAA 1936.

Question 4

Summary

The Commissioner will not make a determination under subsection 204-30(3) of the ITAA 1997 that section 204-30 applies to the whole, or any part, of the Dividend Component of the Buy-Back Price.

Detailed reasoning

Subsection 204-30(1) of the ITAA 1997 applies where a corporate tax entity streams the payment of dividends, or the payment of dividends and the giving of other benefits, to its members in such a way that:

(a) an imputation benefit is, or apart from this section would be, received by a member of the entity as a result of the distribution or distributions, 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.

Relevantly, if section 204-30 of the ITAA 1997 applies, the Commissioner is vested with a discretion under subsection 204-30(3) to make a determination in writing either:

(a) that a specified franking debit arises in the franking account of the entity, for a specified distribution or other benefit to a disadvantaged member

(b) that a specified exempting debit arises in the exempting account of the entity, for a specified distribution or other benefit to a disadvantaged member, or

(c) that no imputation benefit is to arise in respect of a distribution that is made to a favoured member and specified in the determination.

An imputation benefit is defined in subsection 204-30(6) of the ITAA 1997 and includes, amongst other things, where a member is entitled to a tax offset under Division 207 of the ITAA 1997 or an amount would be included in the member's assessable income pursuant to section 207-35 of the ITAA 1997.

Attached to the Dividend Component of the Buy-Back, a Shareholder will receive an imputation benefit in accordance with subsection 204-30(6) of the ITAA 1997. Accordingly, paragraph 204-30(1)(a) is satisfied.

Paragraph 204-30(1)(b) of the ITAA 1997 requires that the Shareholder must derive a greater benefit from imputation benefits received under the Buy-Back than the other members of the Company who do not participate in the Buy-Back. The words 'derive a greater benefit from franking credits' (imputation benefits) are defined in subsection 204-30(8) by reference to the ability of the members to fully utilise imputation benefits.

As all Shareholders are Australian residents for income tax purposes and can both fully utilise imputation benefits, it is considered that the Shareholder will not derive a greater benefit from receiving a franked distribution than other shareholders. Accordingly, paragraph 204-30(1)(b) of the ITAA 1997 is not satisfied in relation to the Buy-Back.

All shareholders have historically been in receipt of franked dividends from the Company and are expected to continue to receive future earnings from the Company as franked dividends. Accordingly, it is considered that paragraph 204-30(1)(c) of the ITAA 1997 is also not satisfied in relation to the Buy-Back. Therefore, it is concluded that the Company will not be taken to direct the flow of dividends in such a manner as to ensure that imputation benefits are derived by members who derive greater benefit from franking credits while other members receive lesser or no imputation benefits. Accordingly, section 204-30 of the ITAA 1997 will not apply to the Buy-Back.

Question 5

Summary

The Commissioner will not make a determination under section 45A of the ITAA 1936 or section 45B of the ITAA 1936 that subsection 45C(3) of the ITAA 1936 will apply in respect of the Capital Component of the Buy-Back.

Detailed reasoning

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 a share buy-back can be treated as an unfranked dividend.

Section 45A of the ITAA 1936

Section 45A of the ITAA 1936 is an anti-avoidance provision that applies in circumstances where capital benefits are streamed to certain shareholders (the advantaged shareholders) who derive a greater benefit from the receipt of share capital and it is reasonable to assume that the other shareholders (the disadvantaged shareholders) have received or will receive dividends.

The provision of capital benefits is defined in subsection 45A(3) of the ITAA 1936 to be:

(a) the provision to the shareholder of shares in the company

(b) the distribution to the shareholder of share capital or share premium

(c) something that is done in relation to a share that has the effect of increasing the value of a share (which may or may not be the same share) held by the shareholder.

The Buy-Back will be a provision of a capital benefit as defined in paragraph 45A(3)(b) of the ITAA 1936 on the basis that the Shareholder will receive the Capital Component as part of the Buy-Back Price.

In order for section 45A of the ITAA 1936 to apply to the Buy-Back, the Commissioner must determine that the Company streamed capital benefits to the advantaged shareholders of who derived a greater benefit from the capital benefits than the disadvantaged shareholders.

Subsection 45A(4) of the ITAA 1936 identifies a number of circumstances where the advantaged shareholders would derive a greater benefit from the capital benefits than the disadvantaged shareholders, as follows:

(a) some or all of the shares in the company held by the shareholder were acquired, or are taken to have been acquired, before 20 September 1985

(b) the shareholder is a non-resident

(c) the cost base (for the purposes of Part IIIAA of the ITAA 1936) of the relevant share is not substantially less than the value of the applicable capital benefit

(d) the shareholder has a net capital loss for the year of income in which this capital benefit is provided

(e) the shareholder is a private company who would not have been entitled to a rebate under former section 46F of the ITAA 1936 if the shareholder had received the dividend that was paid to the disadvantaged shareholder, and

(f) the shareholder has income tax losses.

Under the Buy-Back, the Shareholder will receive the Capital Component and Dividend Component. As stated earlier, the Commissioner accepts that the method to calculate the proposed dividend/capital split under the Buy-Back is appropriate in the circumstances.

In this regard, it is considered that the Company is not discriminating between shareholders in the Buy-Back as the circumstances of the Buy-Back indicate that there is no streaming of capital benefits to some shareholders and dividends to other shareholders.

It is considered that the Shareholder is not an advantaged shareholder who receives capital benefits whilst other shareholders receive dividends as the Shareholder received both the Capital Component and Dividend Component based on the number of shares it sold in the Buy-Back.

Accordingly, section 45C(1) of the ITAA 1936 will not apply to deem any part of that Capital Component to be an unfranked dividend in the hands of the Shareholder. Therefore, the Commissioner will not make a determination under subsection 45A(2) of the ITAA 1936 that section 45C applies to the whole, or part, of the Capital Component of the Buy-Back Price to be received by the participating shareholder.

Section 45B of the ITAA 1936

Subsection 45B(2) of the ITAA 1936 provides that section 45B applies where:

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

(b) under the scheme, a taxpayer (the relevant taxpayer), who may or may not be the person provided with the demerger benefit or the capital benefit, obtains a tax benefit, and

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

A "scheme" is defined in section 177A of the ITAA 1936 to mean:

(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.

In this case, the Buy-Back would constitute a "scheme".

A capital benefit is defined in subsection 45B(5) of the ITAA 1936 as any of the following:

(a) the provision of shares in a company to the person

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

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

As the Shareholder will receive the Capital Component of the Buy-Back, they will be provided with a capital benefit under the Buy-Back in accordance with paragraph 45B(5)(b) of the ITAA 1936. Therefore the conditions of paragraph 45B(2)(a) are met.

Paragraph 45B(2)(b) of the ITAA 1936 requires that, under the scheme, a taxpayer obtains a tax benefit. Subsection 45B(9) broadly provides that a taxpayer obtains a tax benefit if an amount of tax payable would be less than the amount of tax otherwise payable (or payable at a later time) had the capital benefit been a dividend.

Paragraph 45B(2)(c) of the ITAA 1936 provides that it is necessary to have regard to the relevant circumstances of the scheme to determine whether a person or persons entered into the scheme for a more than incidental purpose of enabling a taxpayer to obtain a tax benefit. The relevant circumstances to be considered are listed in subsection 45B(8) of the ITAA 1936.

From consideration of the subsection 45B(8) of the ITAA 1936 factors including those contained in subparagraphs 177D(2)(a) to (h) of the ITAA 1936, it is not concluded that the Company will enter into or carry out the Buy-Back or any part of the arrangement for a more than incidental purpose of enabling Shareholder to obtain a tax benefit. The tax benefit that arises to the Shareholder is considered to be incidental to the commercial purposes of the Buy-Back.

Having regard to the 'relevant circumstances' of the scheme (the Buy-Back), as set out in the paragraphs contained in subsection 45B(8) of the ITAA 1936, the inclusion of the Capital Component as part of the Buy-Back Price is appropriate.

Further, it is considered that 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, the Commissioner will not make a determination under section 45B of the ITAA 1936 that section 45C of the ITAA 1936 applies to deem any part of that Capital Component to be an unfranked dividend in the hands of the Shareholder under the Buy-Back.