Edited version of private advice

Authorisation Number: 1051786223379

Date of advice: 11 December 2020

Ruling

Subject: Off market share buy-back

Question 1

Will the share buy-back (the Buy-Back) by the Taxpayer be an "off-market purchase" for the purposes of section 159GZZZK of the Income Tax Assessment Act 1936 (ITAA 1936)?

Answer

Yes.

Question 2

Will the Commissioner accept the dividend/capital split of the Buy-Back as determined using the average capital per share (ACPS) methodology for the purposes of section 159GZZZP of the ITAA 1936?

Answer

Yes.

Question 3

Will the Commissioner make a determination under section 204-30(3)(c) of the Income Tax Assessment Act 1997 (ITAA 1997) to the transactions constituting the Buy-Back?

Answer

No.

Question 4

Will the Commissioner make a determination under subsection 177EA(5)(a) of the ITAA 1936 in relation to the Buy-Back?

Answer

No.

Question 5

Do the general value shifting rules under Division 725 of the ITAA 1997 apply to the Buy-Back?

Answer

No.

This ruling applies for the following period:

1 July 20XX to 30 June 20YY

The scheme commences on:

Year ended 30 June 20XX

Background

The Buy-Back

The Taxpayer is a private company that was incorporated in Australia. It is an Australian proprietary company limited by shares.

The Taxpayer proposes to undertake the Buy-Back to allow certain shareholders (Participating Shareholders) to exit their investment.

The Taxpayer proposes to offer to buy-back ordinary shares in the Taxpayer (Shares) for a particular purchase price per share (Purchase Price).

The Buy-Back will be effected as an off-market buy-back.

All of the shareholders of The Taxpayer (Shareholders) are residents of Australia for tax purposes.

All of the Shareholders have consented to the Buy-Back.

Participation in the Buy-Back was offered to all Shareholders. Not all Shareholders chose to participate in the Buy-Back.

The Buy-Back will take place at a future date.

The Buy-Back Purchase Price is the same for all Participating Shareholders.

Non-participating shareholders have not received and are not entitled to receive any property, dividends or distributions as compensation for not participating in the Buy-Back.

The dividend component of the Buy-Back Purchase Price will be fully franked.

The purchase price for the Buy-Back and the market value of the Shares are the same per Share. This price was negotiated between the parties involved in the Buy-Back and takes into account a number of factors.

Allocation of the Buy-Back Price

The Buy-Back Price will be apportioned as follows per share:

•         An amount will be debited against The Taxpayer's share capital account (Capital Component); and the balance of the Buy-Back Price will be debited against the retained earnings account of The Taxpayer (Dividend Component).

•         These amounts had been determined using the average capital per share (ACPS) methodology.

For the purposes of the ruling a number of documents provided with The Taxpayer's private binding ruling application also form part of the facts.

Relevant legislative provisions

Income Tax Assessment Act 1936 section 159GZZZK

Income Tax Assessment Act 1936 section 159GZZZP

Income Tax Assessment Act 1936 section 177EA

Income Tax Assessment Act 1997 section 204-30

Income Tax Assessment Act 1997 Division 725

Reasons for Decision

Question 1

Summary

The share buy-back (the Buy-Back) by The Taxpayer will be an 'off-market purchase' for the purposes of section 159GZZZK of the Income Tax Assessment Act 1936 (ITAA 1936).

Detailed reasoning

Share buy-backs are mainly governed by Division 16K of Part III of the ITAA 1936 (Division 16K). This division applies where a company buys a share in itself from a shareholder. Section 159GZZZK of the ITAA 1936 defines the schemes that are covered in Division 16K.

Section 159GZZZK of the ITAA 1936 provides that:

For the purposes of this Division, where a company buys a share in itself from a shareholder in the company:

(a)  the purchase is a buy-back; and

(b)    the shareholder is the seller; and

(c)    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 buy-back is an on-market purchase; and

(d)    if the buy-back is not covered by paragraph (c) - the buy-back is an off-market purchase.

The Taxpayer bought shares in itself from shareholders in the company, therefore the purchase is a buy-back. The Taxpayer's shares are not listed for quotation in the official list of a stock exchange in Australia or elsewhere and the Buy-Back is not made in the ordinary course of trading on that stock exchange. Therefore, the Buy-Back is an off-market purchase pursuant to paragraph 159GZZZK(d) of the ITAA 1936.

Question 2

Summary

The Commissioner will accept the dividend/capital split of the Buy-Back determined using the average capital per share (ACPS) methodology for the purposes of section 159GZZZP of the ITAA 1936.

Detailed reasoning

ACPS methodology

Practice Statement Law Administration 2007/9 (PS LA 2007/9) provides instruction and practical guidance on the application of various taxation laws in connection with share buy-backs. PS LA 2007/9 provides guidance on the application of section 159GZZZP of the ITAA 1936. Section 159GZZZP relevantly provides that:

(1) For the purposes of this Act, but subject to subsection (1A), where a buy-back of a share or non-share equity interest by a company is an off-market purchase, the difference between:

(a)  the purchase price; and

(b)  the part (if any) of the purchase price in respect of the buy-back of the share or non-share equity interest which is debited against amounts standing to the credit of:

(i)            the company's share capital account if it is a share that is bought back; or

(ii)           the company's share capital account or non-share capital account if it is a non-share equity interest that is bought back;

is taken to be a dividend paid by the company:

(c)    to the seller as a shareholder in the company; and

(d)    out of profits derived by the company; and

(e)    on the day the buy-back occurs.

...

(2) The remainder of the purchase price is taken not to be a dividend for the purposes of this Act.

For the purposes of section 159GZZZP of the ITAA 1936, PS LA 2007/9 indicates that the ACPS method is the preferred methodology for determining the 'dividend/capital split' in an off-market share buy-back unless companies can demonstrate exceptional circumstances for the use of an alternative method (paragraph 12 and 69 of PS LA 2007/9). The Commissioner accepts that the ACPS methodology used by The Taxpayer is the appropriate method for determining the 'dividend/capital split' of the Buy-Back price.

Dividend/capital split

Paragraph 62 of PS LA 2007/9 explains that 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 the Buy-Back price would be a dividend. The Taxpayer has a certain number of ordinary shares on issue with a total issued capital of a certain amount, therefore the ACPS per shares is worked out to be the amount of share capital divided by the number of shares.

Therefore, for the purposes of section 159GZZZP, a certain amount will represent the capital component (Capital Component) of the Buy-Back Price and the balance of a certain amount will present the dividend component (Dividend Component) of the Buy-Back Price for each share bought back.

Question 3:

Summary

The Commissioner will not make a determination under paragraph 204-30(3)(a) of the Income Tax Assessment Act 1997 (ITAA 1997) that a specified franking debit arises in the franking account of The Taxpayer in respect of the whole or part of the Dividend Component.

Detailed reasoning

Section 204-30 of the ITAA 1997 empowers the Commissioner to make certain determinations 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 (paragraph 204-30(1)(a) of the ITAA 1997); and

(b)  the member would derive a 'greater benefit from franking credits' than another member of the entity (paragraph 204-30(1)(b) of the ITAA 1997); 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 (paragraph 204-30(1)(c) 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).

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, relevantly:

(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 (paragraph 204-30(3)(a)); or

(b)  that no imputation benefit is to arise in respect of any streamed distribution made to a favoured member and specified in the determination (paragraph 204-30(3)(c)).

For section 204-30 to apply, a member of an entity must derive a greater benefit from franking credits. 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. Some of the cases in which a member of an entity 'derives a greater benefit from franking credits' are listed in subsection 204-30(8) by reference to the ability of a member to fully utilise franking credits.

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

Under the Buy-Back, 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. What occurred under the Buy-Back does not constitute streaming of distributions to favoured shareholders. The imputation benefit provided to the Participating Shareholders will be merely incidental to the exit of those shareholders from the Company.

The Taxpayer will pay equivalent dividends to each Participating Shareholders and none of The Taxpayer's Shares are held by non-resident shareholders who do not benefit from franking credits to the same extent as resident shareholders. Therefore, the conditions in subsection 204-30(1) of the ITAA 1997 will not be met.

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)(c)of the ITAA 1997 will be made.

Question 4

Summary

The Commissioner will not exercise his discretion to make a determination pursuant to paragraph 177EA(5)(a) of the ITAA 1936 that a franking debit arises in The Taxpayers franking account in respect of the whole or part of the franked Dividend Component 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 designed to obtain 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 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.

Where section 177EA of the ITAA 1936 applies, the Commissioner has the discretion to make a determination to debit a companies' franking account pursuant to paragraph 177EA(5)(a) of the ITAA 1936.

The conditions of paragraphs 177EA(3)(a) to 177EA(3)(d) of the ITAA 1936 are satisfied in respect of the Buy-Back. Accordingly, the issue is whether, having regard to the relevant circumstances of the scheme, it would be concluded that on the part of The Taxpayer, its Shareholders or any other relevant party, there was more than a merely incidental purpose of conferring an imputation benefit under the scheme. In respect of the Buy-Back, the relevant taxpayers are the Participating Shareholders and the scheme comprises the circumstances surrounding the Buy-Back.

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 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 purpose.

The Buy-Back is being carried out to allow Participating Shareholders to exit their investment. Based on the information provided and the qualifications set out in this Ruling, the Commissioner's consideration of all of the relevant circumstances of the scheme would not, on balance, lead to a conclusion that the purpose of enabling Participating Shareholders to obtain imputation benefits is more than incidental.

The proposed transaction involving the buy-back of shares is not being carried out for a more than incidental purpose of enabling taxpayers to obtain an imputation benefit. As a result, and having regard to the relevant circumstances of the scheme, the five conditions in 177EA(3) of the ITAA 1936 have not been satisfied and section 177EA will not apply to any fully franked distribution under the proposed transaction.

Where section 177EA of the ITAA 1936 does not apply, the Commissioner does not have discretion to make a determination to debit The Taxpayer's franking account pursuant to paragraph 177EA(5)(a) of the ITAA 1936.

Therefore, in this case, the Commissioner will not be empowered to use his discretion in such a way as to debit The Taxpayer's franking account pursuant to paragraph 177EA(5)(a).

Question 5

Summary:

The Buy-Back will not give rise to a direct value shift under Division 725 of the ITAA 1997.

Detailed reasoning

Division 725 of the ITAA 1997 deals with a direct value shift which occurs under a scheme involving equity or loan interests in an entity where there is a decrease in the market value of some equity or loan interests and an increase or issue at a discount of other equity or loan interests.

A direct value shift is defined at subsection 725-145(1) of the ITAA 1997 as follows:

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 also give rise to direct value shifting consequences (paragraphs 149 to 152 of PSLA 2007/9).

Given the Buy-Back price is equal to the market value of the Shares there has been no buy-back at a premium or a discount. Therefore, section 725-145 of the ITAA 1997 will not be satisfied and the Buy Back will not give rise to a direct value shift.