Edited version of private advice

Authorisation Number: 1051845844250

Date of advice: 8 June 2021

Ruling

Subject: Off-market share buy-back

Question 1

(a) Will the disposal of Company B shares by Company A satisfy the preconditions for a reduction to the capital gain amount pursuant to subsection 768-505(1) of the Income Tax Assessment Act 1997 (ITAA 1997)?

(b) Will the active foreign business asset percentage of Company B as determined by the method statement in subsection 768-520(1) of the ITAA 1997 be 100%?

Answer

1(a) Yes.

1(b) Yes.

Question 2

Will the proposed share Buy-Back constitute an off-market purchase within the meaning of section 159GZZZK of the Income Tax Assessment Act 1936 (ITAA 1936)?

Answer

Yes

Question 3

Is $XXX taken to be a dividend paid by Company A out of profits derived by the company on the day the Buy-Back occurs, in accordance with section 159GZZZP of the ITAA 1936?

Answer

Yes

Question 4

Will paragraph 202-45(c) of the ITAA 1997 apply in respect of the Dividend Component of the Buy-Back?

Answer

No

Question 5

Will the Commissioner make a determination under paragraph 204-30(3)(a) of the ITAA 1997 that a franking debit arises in respect of the Buy-Back?

Answer

No

Question 6

Will the Commissioner 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?

Answer

No

Question 7

Will the Commissioner make a determination pursuant to paragraph 177EA(5)(a) of the ITAA 1936 that a franking debit arises in respect of the Buy-Back?

Answer

No

Question 8

Can the amount of the Buy-Back price attributable to a dividend pursuant to section 159GZZZP of the ITAA 1936 be declared conduit foreign income (CFI) by Company A in accordance with Division 802 of the ITAA 1997?

Answer

Yes

Question 9

Will the Commissioner apply the CFI streaming provisions in section 802-60 of the ITAA 1997 to the Buy-Back?

Answer

No

Question 10

Based on the anticipated CFI balances of $YYY and the Dividend Component of the Buy-Back being $XXX, will an administrative penalty under section 288-80 of Schedule 1 to the Taxation Administration Act 1953 (TAA 1953) apply as a result of the share Buy-Back?

Answer

No

This ruling applies for the following periods:

Year ended 30 June 2021 and

Year ended 30 June 2022

The scheme commences on:

In the income year ending 30 June 2021

Relevant facts and circumstances

Background

Company A is an Australia resident private company which owns 100% of the shares in Company B. Company B is a foreign resident company for tax purposes.

Company A has two shareholders C and D each owns 50% of the shares in Company A. Shareholder C and D are both Australia resident companies.

Both Company A and Company B are carrying a business in the same industry.

Company B has only one class of shares and the shares were held by Company A for more than 24 months prior the transactions.

Transactions

Company A proposes to sell all shares in Company B to Shareholder C's associate (the Disposal) and to undertake an off-market share buy-back of ordinary shares currently held by Shareholder C (the Buy-Back).

The parties executed a Share Sale Deed and a Buy-back Agreement.

Company A agreed to sell and Shareholder C's associate agreed to purchase the shares in Company B at market value.

Shareholder C agreed to sell and Company A agreed to purchase the Buy-back Shares held by Shareholder C at market value, and in accordance with the terms of the Agreement.

The Buy-Back Price comprised a dividend component (Dividend Component) and capital component (Capital Component).

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

The Capital Component will be debited to share capital.

Company A will declare the Dividend Component conduit foreign income(CFI), and had sufficient CFI balance to that extent.

Company A will make no other distributions during the franking period in which the Buy-Back occurs.

Relevant legislative provisions

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 subsection 45C(3)

Income Tax Assessment Act 1936 section 177EA

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

Income Tax Assessment Act 1936 section 159GZZZK

Income Tax Assessment Act 1936 paragraph 159GZZZK(d)

Income Tax Assessment Act 1936 section 159GZZZP

Income Tax Assessment Act 1936 subsection 159GZZZP(1)

Income Tax Assessment Act 1936 section 327

Income Tax Assessment Act 1936 section 327A

Income Tax Assessment Act 1997 section 104-10

Income Tax Assessment Act 1997 section 202-45

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

Income Tax Assessment Act 1997 section 204-30

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

Income Tax Assessment Act 1997 Subdivision 768-G

Income Tax Assessment Act 1997 subsection 768-505(1)

Income Tax Assessment Act 1997 paragraphs 768-505(1)(a)

Income Tax Assessment Act 1997 paragraphs 768-505(1)(b)

Income Tax Assessment Act 1997 paragraphs 768-505(1)(c)

Income Tax Assessment Act 1997 section 768-510

Income Tax Assessment Act 1997 subsection 768-515(2)

Income Tax Assessment Act 1997 section 768-520

Income Tax Assessment Act 1997 subsection 768-520(1)

Income Tax Assessment Act 1997 section 768-540

Income Tax Assessment Act 1997 subsection 768-540(1)

Income Tax Assessment Act 1997 subsection 768-540(2)

Income Tax Assessment Act 1997 Division 802

Income Tax Assessment Act 1997 section 802-15

Income Tax Assessment Act 1997 section 802-20

Income Tax Assessment Act 1997 subsection 802-20(1)

Income Tax Assessment Act 1997 subsection 802-20(2)

Income Tax Assessment Act 1997 section 802-30

Income Tax Assessment Act 1997 section 802-60

Income Tax Assessment Act 1997 section 995-1

Schedule 1 to the Taxation Administration Act 1953 section 288-80

Reasons for decision

Question 1

Summary

(a) The disposal of Company B shares by Company A satisfies the preconditions for a reduction to the capital gain amount pursuant to subsection 768-505(1) of the ITAA 1997.

(b) The active foreign business asset percentage of Company B as determined by the method statement in subsection 768-520(1) of the ITAA 1997 is 100%.

Detailed reasoning

(a)

Under Subdivision 768-G of the ITAA 1997, where an Australian corporate tax entity has a capital gain or capital loss arising from a CGT event that happens in relation to a share in a foreign company that it holds a direct voting percentage of 10% or more before the CGT event happens, the gain or loss is reduced by a percentage that reflects the degree to which the assets of the foreign company Are used in an active business.

Subsection 768-505(1) of the ITAA 1997 provides certain criteria that must be satisfied as precondition for a reduction to the capital gain or capital loss amount.

Company A is an Australian resident and Company B is a foreign resident pursuant to subsection 995-1(1) of the ITAA 1997. Conditions in paragraphs 768-505(1)(a), (b) and (c) of the ITAA 1997 are satisfied because:

•         For 24 months before the time of the CGT event to just before the disposal, Company A holds 100% ordinary shares on issue in Company B which have equal voting power according to Company B's articles of association. Therefore Company A held a direct voting of more than 10% in Company B.

•         The share in Company B is not an eligible finance share as defined in section 327 of the ITAA 1936 or a widely distributed finance share section 327A of the ITAA 1936.

•         The disposal of shares in Company B from Company A to Shareholder C's associate constitutes CGT event A1 pursuant to section 104-10 of the ITAA 1997.

Therefore the disposal of Company B shares by Company A satisfies conditions for a reduction to the capital gain or capital loss amount pursuant to subsection 768-505(1) of the ITAA 1997.

(b)

Section 768-510 of the ITAA 1997 prescribes three methods which the holding company can elect to apply to calculate the active foreign business asset percentage: the market value method, the book value method or the default method.

Company will elect to use the market value method under subsection 768-515(2) of the ITAA 1997.

Company A has provided a valuation report of the market values of assets in Company B as at 28 February 2021. The Commissioner is satisfied that the market valuation report produced is sufficient evidence of the market value at the time of disposal.

The methodology to be applied in using the market value method is set out in section 768-520. Specifically, subsection 768-520(1) prescribes the method statement that the active foreign asset business percentage of the foreign holding company at the time of the CGT event is to be calculated.

The definition of active foreign business assets is set-out in section 768-540 of the ITAA 1997.

Company B carries on an active business. As such, except assets which are specifically excluded by subsection 768-540(2) of the ITAA 1997 or subsection 768-540(1) of the ITAA 1997 is applied to work out the value under step 2.

Using the market value method, Company B's active foreign asset business percentage is above 90%. Pursuant to step 5 of the method statement in section 768-520(1), as the result of step 4 is greater than 90%, the active foreign business asset percentage of Company B as determined by the method statement in subsection 768-520(1) of the ITAA 1997 is 100%.

Question 2

Summary

The proposed share Buy-Back constitutes an off-market purchase within the meaning of section 159GZZZK of the ITAA 1936.

Detailed reasoning

Section 159GZZZK of the ITAA 1936 provides:

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.

Company A will buy shares in itself from one of its shareholders therefore the purchase is a buy-back. Company A'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 3

Summary

$XXX is taken to be a dividend paid by Company A out of profits derived by the company on the day the Buy-Back occurs, in accordance with section 159GZZZP of the ITAA 1936

Detailed reasoning

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.

In the context of the buy-back of Company A shares, subsection 159GZZZP(1) of the ITAA 1936 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

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

The dividend is also taken under subsection 159GZZZP(1) of the ITAA 1936 to be paid out of profits derived by Company A, and on the day of the Buy-Back.

The amount will be debited against Company A's share capital account is calculated by reference to the average capital per share (ACPS) which is consistent with Law Administration Practice Statement PS LA 2007/9 Share Buy-Backs.

As such the amount of dividend under subsection 159GZZZP(1) of the ITAA 1936 is $XXX.

Question 4

Summary

Paragraph 202-45(c) of the ITAA 1997 will not apply in respect of the Dividend Component of the Buy-Back

Detailed reasoning

Section 202-45 of the ITAA 1997 provides a list of distributions that are unfrankable, in particular, subsection 202-45(c) of the ITAA 1997 provides:

(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;

Based on the valuation report provided, the Commissioner is satisfied that the market value of Buy-Back shares as at the valuation date is what would be the market value 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. Therefore the purchase price will not exceed what would be the market value of the share at the time of the Buy-Back. As such paragraph 202-45(c) of the ITAA 1997 will not apply in respect of the Dividend Component of the Buy-Back.

Question 5

Summary

Commissioner will not make a determination under paragraph 204-30(3)(a) of the ITAA 1997 that a franking debit arises in respect of the Buy-Back

Detailed reasoning

Subsection 204-30(1) of the ITAA 1997 states that the section empowers the Commissioner to make certain determinations if an entity:

... streams one or more *distributions (or one or more distributions and the giving of other benefits), ...in such a way that:

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

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

(c)          the other member of the entity will receive lesser imputation benefits, or will not receive any imputation benefits, whether or not the other member receives other benefits.

The requirements of subsection 204-30(1) of the ITAA 1997 are not satisfied in respect of the Buy-Back as Company A will not frank the Dividend Component of the Buy-Back Price as such Shareholder C will not receive an imputation benefit (within the meaning given by subsection 204-30(6) of the ITAA 1997) as a result of receiving the Dividend Component of the Buy-Back Price.

As such the Commissioner will not make a determination pursuant to paragraph 204-30(3)(a) of the ITAA 1997.

Question 6

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 the buy-back is treated as an unfranked dividend.

Section 45A of the ITAA 1936 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 distribution of share capital to Shareholder C by Company A under the Buy-Back is a 'provision of a capital benefit' as defined in paragraph 45A(3)(b) of the ITAA 1936. However the circumstances of the Buy-Back indicate that there is no streaming of capital benefits to some shareholders and dividends to other shareholders, in particular:

• The circumstances of Shareholder C and Shareholder D do not support that in the year of income, Shareholder C will derive a greater benefit of capital benefits than Shareholder D.
• The nature of the arrangement is not a substitute for ordinary dividends.

Accordingly, section 45A of the ITAA 1936 has no application to the Buy-Back.

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:

(a) there is a scheme under which a person is provided with a capital benefit by a company;

(b) under the scheme, a taxpayer, who may or may not be the person provided with 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 to obtain a tax benefit.

The Buy-Back constitutes a 'scheme' within the meaning given by subsection 995-1(1) of the ITAA 1997. As set out above Shareholder C will be 'provided with a capital benefit' under the Buy-Back in the form of a distribution of share capital. As a result, the requirements of paragraph 45B(2)(a) of the ITAA 1936 regarding the provision of a capital benefit is satisfied in respect of the Buy-Back.

Broadly, a relevant taxpayer 'obtains a tax benefit' under the Buy-Back if the amount of tax payable by the taxpayer 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) of the ITAA 1936). Taken into consideration of Shareholder C's circumstances including its cost base of shares in Company A, the tax payable 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. As such, the requirements paragraph 45B(2)(b) of the ITAA 1936 is satisfied.

Paragraph 45B(2)(c) of the ITAA 1936 provides that it is necessary to have regard to the 'relevant circumstances' of the Buy-Back to determine whether Company A or Shareholder C entered into or carried out the Buy-Back for a more than incidental purpose of enabling Shareholder C to obtain a tax benefit.

The relevant circumstances to be considered are listed in subsection 45B(8) of the ITAA 1936 and include any of the matters listed in subsection 177D(2) of the ITAA 1936.

Following a consideration of the relevant circumstances of the Buy-Back, the Commissioner accepts that neither Company A nor Shareholder C entered into or carried out the Buy-Back for a more than incidental purpose of enabling a Participating Shareholder to obtain a tax benefit.

Accordingly, section 45B of the ITAA 1936 does not apply to the Buy-Back. The Commissioner will not make a determination under either section 45A or section 45B of the ITAA 1936 that section 45C of the ITAA 1936 applies to treat all or part of the capital component of the Buy-Back price as an unfranked dividend.

Question 7

Summary

The Commissioner will not make a determination pursuant to section 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 operates to safeguard the imputation system 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) 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 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 of the ITAA 1936 to apply, the five specific conditions set out in paragraphs 177EA(3)(a) to (e) of the ITAA 1936 must each be present (conjunctive). In this case as the dividend will not be a franked distribution nor a distribution franked with an exempting credit, paragraph 177EA(3)(c) of the ITAA 1936 is not satisfied. It follows that the Commissioner will not make a determination pursuant to section 177EA(5)(a) of the ITAA 1936 that a franking debit arises in respect of the Buy-Back.

Question 8

Summary

The amount of the Buy-Back price attributable to a dividend pursuant to section 159GZZZK of the ITAA 1936 can be declared CFI by Company A in accordance with Division 802 of the ITAA 1997

Detailed reasoning

Subdivision 802-A of the ITAA 1997 sets out the method of working out an entity's CFI which includes the following amounts:

•         The ordinary or statutory income you derive, providing further that certain conditions, assumptions and adjustments are satisfied or made (subsections 802-30(1) and (2) of the ITAA 1997)

•         An unfranked part of a frankable distribution you receive directly from another Australian corporate tax entity, or indirectly through a trust or partnership, to the extent it is declared to be CFI (paragraphs 802-30(3)(a) and (3)(b) of the ITAA 1997); and

•         A foreign equity distribution you receive directly from a foreign resident company, or indirectly through a trust or partnership, that is not assessable, not exempt income pursuant to section 768-5 (paragraph 802-30(3)(c) of the ITAA 1997)

In this case, the dividend distribution of $XXX is an unfranked frankable distribution paid by an Australian corporate tax entity. Therefore the dividend distribution meets the criteria to be considered conduit foreign income in accordance with section 802-30 of the ITAA 1997.

Under item (c) of section 202-45 of the ITAA 1997, where the buy-back price exceeds what would be the market value of the shares at the time of the buy-back (if the buy-back did not take place and were never proposed to take place), the excess amount is unfrankable. Should the buy-back price exceed the market value of the shares the excess will be an unfrankable amount and cannot be declared CFI (section 802-15 of the ITAA 1997). As discussed in detailed reasoning for question 4, the Commissioner does not consider there will be an excess amount to the market value of the shares, therefore the Commissioner considers the full Dividend Component is frankable and can be declared as CFI.

Question 9

Summary

The Commissioner will not apply the CFI streaming provisions in section 802-60 of the ITAA 1997 to the Buy-Back

Detailed reasoning

Section 802-10 of the ITAA 1997 is anti-streaming provision which prevents streaming of unfranked distributions to foreign shareholders in preference to resident shareholders.

Subsection 802-60(2) provides:

(2) If the entity does not, for that franking period, declare the same proportion of conduit foreign income for all membership interests and non-share equity interests then, instead of the amount that it declared to be conduit foreign income on those distributions, it is taken to have declared under section 802- 45 the greater amount that it would have declared had it declared that same proportion on all those distributions.

Company A has a franking period that is the same as its income year pursuant to section 203-45 of the ITAA 1997. At the time of the Buy-Back, Company A will declare the same proportion of CFI for all shares in itself that it buys from Shareholder C and Company A will make no other distributions during the franking period in which the Buy-Back occurs. Therefore subsection 802-60(2) of ITAA 1997 is not satisfied as such the Commissioner will not apply the CFI streaming provisions in section 802-60 of the ITAA 1997 to the Buy-Back.

Question 10

Summary

Based on the anticipated CFI balances of $YYY and the dividend component of the Buy-Back being $XXX, an administrative penalty under section 288-80 of Schedule 1 to the TAA 1953 will not apply as a result of the share Buy-Back

Detailed reasoning

Section 288-80 of Schedule 1 to the TAA 1953 imposes an administrative penalty for over declaring conduit foreign income. It provides:

An • Australian corporate tax entity is liable to an administrative penalty if:

(a) the entity makes a * frankable distribution that has an * unfranked part; and

(b) the entity declares an amount of the unfranked part to be * conduit foreign income; and

(c) the sum of the amounts declared exceeds the amount of the entity's conduit foreign income at:

(i) if the entity declares the distribution before making the distribution--the time of the declaration; or

(ii) otherwise--the time the distribution is made.

On the basis that the declared CFI amount is less than the balance of Company A's CFI account, an administrative penalty under section 288-80 of Schedule 1 to the TAA 1953 will not apply as a result of the share Buy-Back