Edited version of private advice

Authorisation Number: 1051837416422

Date of advice: 10 August 2021

Ruling

Subject: Off-market share buy-back

Question 1

Will any part of the buy-back price be treated as a dividend under section 159GZZZP of the Income Tax Assessment Act 1936 (ITAA 1936)?

Answer

No

Question 2

Will there be an adjustment to the Purchase Price the sellers are treated as having received under the buy-back for the purposes of Part 3-1 and 3-3 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

No - relevantly, the market value of each share in the company at the relevant time will be less than $1, the buy-back proceeds will be $1 per share and the average capital per share is $1.

Question 3

Will the Commissioner make a determination that section 45C of the ITAA1936 applies to the buy-back by virtue of section 45A of the ITAA1936?

Answer

No

Question 4

Will the Commissioner make a determination that section 45C of the ITAA 1936 applies to the buy-back by virtue of section 45B of the ITAA1936?

Answer

No

This ruling applies for the following period:

From the commencement of the share buy-back to end of the income year in which the share buy-back commenced.

Relevant facts and circumstances

Company Pty Ltd was incorporated in Australia before 1985.

Company Pty Ltd shares are not listed for quotation in the official list of a stock exchange in Australia or elsewhere.

Company Pty Ltd has XXXXX fully paid ordinary shares on issue - and a total of $XXXXX recorded in the Company Pty Ltd's 'share capital account'.

The shares are held by the Controller of Company Pty Ltd (Individual - 'Controller') and their Family Discretionary Trust (the 'the Trust').

The shareholders of Company Pty Ltd are Australian residents for tax purposes and are long-term shareholders.

The Trustee of the Trust is a company - the shareholders and directors of which are the Controller and their spouse.

The following characteristics are relevant to the shareholdings:

•         All shares are were acquired after 20 September 1985

•         The shareholders are both Australian Tax Residents

•         Neither Shareholder has any carried forward capital losses

•         Neither Shareholder is a Private Company

•         Neither Shareholder has carried forward tax losses

•         The Cost Base - for CGT Purposes - of the parcels are set out below.

Dividends have been declared, the company has retained earnings, a negative capital reserve and the company has $X,XXX,XXX amount of equity.

Retained Earnings have not been offset against the negative reserve balance to date.

There have been no asset sales or disposals of any part of the business structure.

As a result of the market conditions Company Pty Ltd nearly went into liquidation - with the Capital Loss reserve reflective of the Shareholders money that was lost at that time. This is not representative of any assets on hand at present - with the reserve dating back to (at least 1994 - which is the earliest year for which we have records).

The reserve is reflective of real losses suffered by Company Pty Ltd - and in the same manner that a Capital Profits

Reserve would increase earnings - it is appropriate for this real loss of capital to be included with the retained profits in determining the funds available to be paid to Shareholders.

Over the years of operation the level of business working capital (including Goodwill) required to maintain and run the business has been approximately $X,XXX,000 - which is significantly below the level of Share Capital held by the business. As a result - the decision has been made by the company director to make a one-off payment to return funds to Shareholders.

Company Pty Ltd has also secured a new finance facility from a Bank - providing it with a greater ability to work with a lower overall level of working capital.

The level of retained earnings in Company Pty Ltd is insufficient to enable the payment of a $X,XXX,000 dividend to shareholders from Retained Earnings.

The Retained Earnings is properly available for distribution to the shareholders (having regard to the principles set out in TR 2012/5 with reference to the application of section 254T of the Corporations Act 2001.)

Company Pty Ltd has chosen to undertake a Share Buy-Back as a method of permanently reducing the level of capital reflected in its Financial Accounts in order to more closely align the committed Share Capital with the Working Capital required by the Business Operations.

In accordance with the Corporations Act 2001 and Company Pty Ltd's constitution, Company Pty Ltd will undertake a share buy-back of X,XXX,000 shares in order to more appropriately match the level of capital in the business with its working capital requirements.

Under the buy-back the X,XXX,000 ordinary shares are bought back from shareholders for $1.00 each. This amount would be debited in full to the Company Pty Ltd's Share Capital Account - reducing this balance to $X,XXX,000.

The shares of both shareholders (i.e. Individual and Corporate Trustee) will be bought back proportionately. That is, their shareholding percentage will not change after the buy-back.

The buy-back is being undertaken by the company to rebalance its capital structure. That is, the company has been able to obtain bank finance for working capital and wants to return part of the share capital to its shareholders.

The buy-back is a genuine capital return to the shareholders.

There have been no movements in the value of the Share Capital Account since 19XX - which was the last time shares in the Company Pty Ltd were issued.

The Shareholders will receive the Capital Proceeds from the buy-back in return for their shares. There are no other changes to the financial position of other persons as a result of the buy-back.

While the parties to the transaction are associates (for the purpose of section 318 of the ITAA1936) - no part of the buy-back will take place under non-arm's length conditions.

The market value of each share, at the relevant time, in Company Pty Ltd is less than $1.

At the time of the buy-back the amount that is the market value of the shares is determined on the basis that the buy- back has not occurred and was never proposed to occur is less than the consideration received.

The buy-back proceeds will be $1 per share.

Company Pty Ltd will use the average capital per share (ACPS) methodology as described in Practice Statement Law Administration PS LA 2007/9 to determine the proportion of the purchase price that is capital and the proportion that is a dividend for the purposes of section 159GZZZP of the ITAA 1936.

The buy-back is being proposed for commercial reasons, both shareholders continue to hold shares in the company and are entitled to the retained earnings of the company, the buy-back proceeds equal the average capital per share amount.

Reasons for decision

These reasons for decision accompany the Notice of private ruling for XXX.

Question 1

Summary

No amount will be treated as a dividend under section 159GZZZP of the ITAA 1936 as the share buy-back purchase price is equal to the amount debited against amounts standing to the credit of Company Pty Ltd's share capital account.

Detailed reasoning

Division 16K of the ITAA 1936

Division 16K of Part III of the ITAA 1936 applies to buy-backs of shares.

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.

Section 159GZZK 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.

As Company Pty Ltd's shares are 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 buy-back arrangement entered into between the shareholders and Company Pty Ltd is an off-market purchase in accordance with section 159GZZZK of the ITAA 1936.

Relevantly, pursuant to paragraph 159GZZZM(a) of the ITAA 1936, the purchase price in respect of shares the company acquires through the buy-back is the amount of money the participating shareholder received or are entitled to receive as a result of or in respect of the buy-back.

Section 159GZZZP relevantly provides:

(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, Practice Statement PSLA 2007/9 states that the Commissioner's preferred methodology for determining the 'split' between the return of capital and dividend paid to participating shareholders in an off-market share buy-back is the average capital per share (ACPS) method unless companies can demonstrate exceptional circumstances for the use of an alternative method (paragraph 12 and 69 of Practice Statement Law Administration PS LA 2007/9).

Pursuant to the scheme, Company Pty Ltd will debit its share capital account. The amount will be determined using the ACPS method. In this case the issued capital amount of $X,XXX,000 is divided by the number of ordinary shares on issue, X,XXX,000, to arrive at the capital component of the split (in this case $1.00).

As the purchase price of the buy-back ($X,XXX,000 for X,XXX,000 shares) will not exceed the amount debited to the Share Capital Account - ($X,XXX,000) - there is no component of the purchase price taken to be a dividend paid by the company on the day the buy-back occurs for the purposes of section 159ZZZP of the ITAA 1936.

Question 2

Summary

Subsection 159GZZZQ(2) of the ITAA 1936 will not apply to adjust the purchase price where the buy-back price is equal to or greater than market value of each buy-back share at the time of the buy-back where the market value is determined as if the buy-back did not occur and was never proposed to occur.

Detailed reasoning

Section 159GZZZQ of the ITAA 1936 outlines how to calculate the consideration received for the disposal of the shares in an off-market share 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 shares bought back.

However, subsection 159GZZZQ(2) of the ITAA 1936 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 of the share as consideration in respect of the sale of the share bought back.

The provision requires that the shares are to be valued at the time of the buy-back. If the market value at the time of the buyback is less than the consideration received, then no adjustment pursuant to subsection 159GZZZQ(2) of the ITAA 1936 is necessary. However, if the market value of the ordinary shares sold at the time of the share buy-back is greater than the consideration received for the shares the consideration is increased to the shares market value, pursuant to subsection 159GZZZQ(2) of the ITAA 1936.

Subsection 159GZZZQ(3) provides that the total amount received is reduced by the dividend component. The remaining amount is the consideration received for the disposal of the shares (capital component). In this case there is no dividend component of the amount received for the ordinary shares sold to Company Pty Ltd under the scheme.

Question 3

Summary

Although a 'capital benefit' (as defined in paragraph 45A(3)(b) of the ITAA 936) was provided under the buy-back, the circumstances of the buy-back indicate that there was no streaming of capital benefits to some shareholders and dividends to other shareholders. Therefore, section 45A of the ITAA 1936 does not apply to the buy-back.

A determination will not be made under subsection 45A(2) of the ITAA 1936 that section 45C of the ITAA 1936 will apply to treat any part of the buy-back value received by any of the shareholders as an unfranked dividend.

Detailed reasoning

Sections 45A of the ITAA 1936 is an anti-avoidance provision which, if it applies, allows 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 applies in circumstances where capital benefits and payment of dividends 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 as:

(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 share buy-back price.

In order for section 45A of the ITAA 1936 to apply to the buy-back, the Commissioner must determine that Company Pty Ltd streamed capital benefits to the advantaged shareholders 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.

Company Pty Ltd will provide its shareholders with a 'capital benefit' (as defined in paragraph 45A(3)(b) of the ITAA 1936) via the proposed return of capital. In accordance with the scheme a capital distribution is made to both Individual and the Trustee.

The shares of both shareholders will be bought back proportionately. That is, their shareholding percentage will not change after the buy-back.

Consequently, there is no advantaged shareholder' - no shareholder will receive a 'greater benefit' than the other shareholder, for the purposes of section 45A of the ITAA 1936.

Accordingly, on the facts, subsection 45C(1) of the ITAA 1936 will not apply to deem any part of that capital benefit to be an unfranked dividend in the hands of a 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 any of the participating shareholders.

Question 4

Summary

Having regard to the relevant circumstances (as set out in subsection 45B(8)) of the ITAA 1936) of the buy-back, it cannot be concluded that a person would have entered into, or carried out, the buy-back for a more than incidental purpose of enabling a participating shareholder to obtain a tax benefit. Therefore, section 45B of the ITAA 1936 does not apply to the buy-back.

A determination will not be made under subsection 45B(3) of the ITAA 1936 that section 45C of the ITAA 1936 will apply to treat the buy-back value, or any part of it received by Individual and Corporate Trustee of the share buy-back, as an unfranked dividend.

Detailed reasoning

Sections 45B of the ITAA 1936 is an anti-avoidance provisions which, if it applies, allows 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 45B of the ITAA 1936 applies where certain capital payments are paid to shareholders in substitution for dividends. In broad terms, section 45B applies where:

1. there is a scheme under which a person is provided with a capital benefit by a company (paragraph 45B(2)(a) of the ITAA 1936);
2. under the scheme, a taxpayer, who may or may not be the person provided with the capital benefit, obtains a tax benefit (paragraph 45B(2)(b) of the ITAA 1936); and
3. having regard to the relevant circumstances of the scheme, it is concluded that the person, or one of the persons, who entered into or carried out the scheme or any part of the scheme did so for a purpose (whether or not the dominant purpose but not including an incidental purpose), of enabling a taxpayer to obtain a tax benefit (paragraph 45B(2)(c) of the ITAA 1936).

The Commissioner considers that the ACPS method gives rise to a strong presumption that sections 45A and 45B of the ITAA 1936 would not apply to the buy-back (see PSLA 2007/9).

Having regard to the relevant circumstances (as set out in subsection 45B(8) of the ITAA 1936) of the buy-back, it cannot be concluded that a person would have entered into, or carried out, the buy-back for a more than incidental purpose of enabling a participating shareholder to obtain a tax benefit. Therefore, section 45B of the ITAA 1936 does not apply to the buy-back

In this case, the Commissioner accepts that section 45B of the ITAA 1936 will not apply:

•         The shares of both shareholders will be bought back proportionately. That is, their shareholding percentage will not change after the buy-back.

•         The buy-back is being undertaken by the company to rebalance its capital structure. That is, the company has been able to obtain bank finance for working capital and wants to return part of the share capital to its shareholders.

•         The buy-back is a genuine capital return to the shareholders.

•         The market value of each share in the company is less than $1.

•         The buy-back proceeds will be $1 per sha.re.

•         Average capital per share (as per the ATO guidelines in PSLA 2007/9) is $1.

•         The retained earnings is properly available for distribution to the shareholders - retained earnings have not been offset against the negative reserve balance.

•         The shareholders are Australian residents for tax purposes and are long-term shareholders.

•         The buy-back is being proposed for commercial reasons, both shareholders continue to hold shares in the company and are entitled to the retained earnings of the company, the buy-back proceeds equal the average capital per share amount etc.

Accordingly, section 45B of the ITAA 1936 has no application to the buy-back.

Therefore, in this case, the Commissioner will not be empowered to make a determination that section 45C of the ITAA 1936 applies.

Accordingly, the Commissioner will not make a determination under subsection 45B(3) of the ITAA 1936 that section 45C of the ITAA 1936 applies to the proposed share buy-back.