Edited version of private advice

Authorisation Number: 1051872366434

Date of advice: 21 July 2021

Ruling

Subject: Off-market share buy-back

Question 1

Will section 159GZZZN of the Income Tax Assessment Act 1936 (ITAA 1936) apply to Company X's off-market share buy-back (Buy-Back)?

Answer

Yes.

Question 2

Will subsection 159GZZZP(1) of the ITAA 1936 apply to Company X such that Company X is taken to pay a dividend out of profits equal to the Dividend Component?

Answer

Yes.

Question 3

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

Answer

Yes.

Question 4

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

Answer

Yes.

Question 5

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

Answer

No.

Question 6

Will the Commissioner make a determination under subsection 45A(2) of the ITAA 1936 that section 45C of the ITAA 1936 applies in relation to the whole, or a part of, the Capital Component?

Answer

No.

Question 7

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

Answer

No.

Question 8

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

Answer

Yes.

Question 9

Will the Commissioner make a determination under paragraph 204-30(3)(a) of the ITAA 1997 in respect of the whole or part of the Dividend Component?

Answer

No.

Questions 10 & 11

The Commissioner has ruled on these questions.

This ruling applies for the following periods:

1 January 20xx to 31 December 20xx.

The scheme commences on:

During the income tax year ended 31 December 20xx.

Relevant facts and circumstances

1.    Company X is an Australian resident. Its shareholders are resident and non-resident individuals, companies and superannuation funds.

2.    Company X undertook an off-market share buy-back of its ordinary shares via a tender process, with all shares bought back being cancelled.

3.    Under the tender process, the discount level for Company X shares bought back was not more than 14% of the volume weighted average price of Company X shares traded on the Australian Securities Exchange over the five trading days up to and including the closing date of the tender period.

4.    Further, Company X did not buy back any shares at a price higher than the deemed market value determined in accordance with:

·         Taxation Determination TD 2004/22: Income tax: for Off-Market Share Buy-Backs of listed shares, whether the buy-back price is set by tender process or not, what is the market value of the share for the purposes of subsection 159GZZZQ(2) of the Income Tax Assessment Act 1936? (TD 2004/22), and

·         Law Administration Practice Statement PS LA 2007/9 Share buy-backs.

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

6.    The Dividend Component of the Buy-Back Price was debited against Company X's retained earnings. The Dividend Component was equal to the Buy-Back Price less the Capital Component. The Dividend Component was fully franked.

7.    The Capital Component of the Buy-Back Price was debited against Company X's untainted share capital account.

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 Division 16K

Income Tax Assessment Act 1936 section 159GZZZK

Income Tax Assessment Act 1936 section 159GZZZN

Income Tax Assessment Act 1936 section 159GZZZP

Income Tax Assessment Act 1936 section 177EA

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 section 960-120

Income Tax Assessment Act 1997 section 995-1

Reasons for decision

All legislative references are to provisions of the ITAA 1936 or the ITAA 1997 unless otherwise stated.

Question 1

Summary

Section 159GZZZN will apply to the Buy-Back such that any subsequent cancellation of the shares bought back are disregarded for the purposes described in paragraphs 159GZZZN(a) and (b).

Detailed reasoning

Under section 159GZZZN, where a company buys-back a share then the Buy-Back, and any

subsequent cancellation of the share, are disregarded for the purposes of:

(a)  determining for the purposes of this Act:

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

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

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

Under the Buy-Back, Company X purchased and cancelled shares in Company X.

Accordingly, the requirements of section 159GZZZN were satisfied, such that the shares bought back and cancelled are disregarded for the purposes described in paragraphs 159GZZZN(a) and (b).

Question 2

Summary

Pursuant to subsection 159GZZZP(1), for each share bought back under the Buy-Back, Company X is taken to have paid Participating Shareholders a dividend out of profits derived by it on the day the Buy-Back occurs equal to the Dividend Component.

Detailed reasoning

Subsection 159GZZZP(1) provides:

For the purposes of this Act, but subject to subsection (1A), where a buy-back of a share or non-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-equity interest which is debited against amounts outstanding 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.

The purchase by Company X of its ordinary shares under the Buy-Back is an off-market purchase as Company X was not purchasing its shares in the ordinary course of trading on an Australian stock exchange (section 159GZZZK).

Company X debited the amount of the Capital Component of the Buy-Back Price to its share capital account.

Accordingly, the difference between the Buy-Back Price and the Capital Component, being the Dividend Component, is taken to be a dividend to Participating Shareholders that was paid out of profits derived by Company X, pursuant to subsection 159GZZZP(1).

Question 3

Summary

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

Detailed reasoning

Subsection 159GZZZP(1) deals with the treatment of a portion of the purchase price in an off-market share buy-back as a dividend for income tax purposes.

For the purposes of paragraph 159GZZZP(1)(e), the day the Buy-Back occurred on is the day that Company X formally accepted buy-back offers from eligible shareholders. At that point in time an agreement was created between Company X and the Participating Shareholders to purchase the shares accepted for the Buy-Back Price.

Question 4

Summary

The entire Dividend Component of the Buy-Back Price is a frankable distribution for the purposes of subsection 202-40(1).

Detailed reasoning

Section 202-40 deals with frankable distributions.

The Dividend Component constitutes a 'distribution' within the meaning given by item 1 of the table in subsection 960-120(1) as '... a dividend, or something that is taken to be a dividend, under this Act', as the Dividend Component is taken to be a dividend pursuant to subsection 159GZZZP(1).

A distribution is a frankable distribution to the extent that it is not unfrankable under section 202-45 (subsection 202-40(1)). As set out in the Detailed reasoning for Question 5 below, no part of the Dividend Component is unfrankable pursuant to section 202-45.

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

Question 5

Summary

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

Detailed reasoning

Section 202-45 deals with unfrankable distributions.

Paragraphs (a) through to (j) of section 202-45 provide a list of distributions that are unfrankable.

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

Paragraph 202-45(c) is relevant to off-market share buy-backs and provides that part of the dividend component is unfrankable to the extent that the buy-back price of a share exceeds the market value of the share at the time of the buy-back if the buy-back did not take place and was never proposed to take place.

TD 2004/22 sets out the Commissioner's view as to how to determine what would have been the market value of a share in Company X at the time of the Buy-Back if the Buy-Back did not occur and was never proposed to occur. In respect of the Buy-Back, the Buy-Back Price per share did not exceed the market value determined in accordance with TD 2004/22. As a result, paragraph 202-45(c) does not apply.

None of the other paragraphs in section 202-45 apply to the Dividend Component of the Buy-Back Price.

Therefore, the entire Dividend Component of the Buy-Back Price is frankable.

Question 6

Summary

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

Detailed reasoning

Section 45A 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 Commissioner may make a determination to the effect that section 45C applies to all or part of a capital benefit. Such a capital benefit is then deemed to be an unfranked dividend.

Participating Shareholders will be provided with a capital benefit under the Buy-Back as share capital will be distributed to Participating Shareholders (paragraph 45A(3)(b)).

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

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

Question 7

Summary

The Commissioner will not make a determination under subsection 45B(3) that section 45C applies in relation to the whole, or a part of, the Capital Component.

Detailed reasoning

Section 45B applies in circumstances where certain capital payments are paid to shareholders in substitution for dividends. In broad terms, section 45B applies to a scheme where:

·         A person is provided with a capital benefit by a company (paragraph 45B(2)(a))

·         A taxpayer (the relevant taxpayer), who may or may not be the person provided with the capital benefit, obtains a tax benefit (paragraph 45B(2)(b)), and

·         It would be concluded having regard to the relevant circumstances (as set out in paragraph 45B(8)) of that scheme 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 more than incidental purpose of enabling the relevant taxpayer to obtain a tax benefit (paragraph 45B(2)(c)).

While the conditions of paragraphs 45B(2)(a) and (b) were met in respect of the Buy-Back, the requisite purpose of enabling a person of enabling a person to obtain a tax benefit as a result of the capital distribution was not present.

Having regard to the "relevant circumstances" (as set out in subsection 45B(8)) of the Buy-Back, it is considered that neither Company X nor the Participating Shareholders entered into or carried out the Buy-Back or any part of the Buy-Back for the requisite purpose of enabling a participating shareholder to obtain a tax benefit. The tax benefit, if any, that may arise for a participating shareholder is incidental to the main or substantial purpose of the Buy-Back.

Accordingly, the Commissioner will not make a determination under subsection 45B(3) in relation to the whole, or any part, of the Capital Component of the Buy-Back Price.

Question 8

Summary

The Commissioner will exercise his discretion to make a determination under paragraph 177EA(5)(a) to raise a franking debit in the franking account of Company X.

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

Detailed reasoning

Section 177EA 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 a buy-back with a franked dividend component.

Specifically, 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 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.

In respect of the Buy-Back, the relevant taxpayer is each shareholder who participated in the Buy-back and the scheme consists of the Buy-Back and the circumstances surrounding the Buy-Back.

The conditions in paragraph 177EA(3)(a) to (d) are satisfied in respect of the Buy-Back for the following reasons:

·         the Buy-Back is a scheme for a disposition of membership interests in a corporate tax entity

·         a frankable distribution (the Dividend Component) will be paid to Participating Shareholders in respect of shares bought under the Buy-Back

·         the Dividend Component will be fully franked, and

·         as a result of receiving the fully franked Dividend Component, Participating Shareholders will receive an imputation benefit within the meaning given by subsection 177EA(16) (those shareholders being entitled to a tax offset under Division 207 as a result of the distribution).

Accordingly, the issue is whether, having regard to the relevant circumstances of the scheme, it would be concluded that, on the part of Company X, its shareholders or any other relevant party, there is a more than incidental purpose of conferring an imputation benefit under the scheme.

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). The relevant circumstances listed in subsection 177EA(17) encompass a range of circumstances which, taken individually or collectively, could indicate the requisite purpose. Due to the diverse nature of these circumstances, some may not be present at any one time in a scheme.

The Commissioner has come to the view that section 177EA applies to the Buy-Back, having regard to all the relevant circumstances of the scheme as outlined in subsection 177EA(17). Among the circumstances of the Buy-Back reflected in subsection 177EA(17) is the greater attraction of the Buy-Back to resident shareholders (because of the franking credits on the Dividend Component of the Buy-Back Price) than to non-resident shareholders.

Where section 177EA applies, the Commissioner has a discretion pursuant to subsection 177EA(5) to make a determination to debit Company X's franking account pursuant to paragraph 177EA(5)(a), or deny the imputation benefit to each participating shareholder pursuant to paragraph 177EA(5)(b).

The Commissioner regards the discount level in respect of the Buy-Back Price as a relevant consideration in the appropriate exercise of his discretion in subsection 177EA(5).

Generally, the Commissioner will exercise his discretion in such a way that paragraph 177EA(5)(a) would be applied to buy-backs where an acceptable level of discount in a tender process buy-back is 14% or less, calculated by reference to the VWAP of the shares bought back for the five days up to and including the closing date of the tender process.

Company X did not buy back shares at a discount greater than 14% under the tender process.

Accordingly, the Commissioner will exercise his discretion to debit Company X's franking account pursuant to paragraph 177EA(5)(a).

The Commissioner will calculate the franking debit to Company X's franking account using the following formula:

Number of shares bought back x Franking Credit attaching to each share bought back x % non-resident shareholders of Company X in tax treaty nations x 0.5

Question 9

Summary

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

Detailed reasoning

Subsection 204-30(1) empowers the Commissioner to make a determination under paragraph 204-30(3)(c) if an entity streams distributions in a certain way.

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

·         participating shareholders received an imputation benefit (within the meaning given by subsection 204-30(6)) as a result of receiving the fully franked Dividend Component of the Buy-Back Price

·         some participating shareholders would have derived a greater benefit from franking credits than other shareholders (for example, non-resident shareholders - see subsection 204-30(7) and 204-30(8)), and

·         it is reasonable to conclude that the features of the Buy-Back influenced some non-resident shareholders not to participate in the Buy-Back, and as a result not receive any imputation benefits in respect of the Buy-Back.

Accordingly, the conditions in subsection 204-30(1) are met and the Commissioner can make a determination under subsection 204-30(3), including a determination under paragraph 204-30(3)(a) to debit Company X's franking account.

As the Commissioner intends to exercise his discretion under section 177EA, the Commissioner will not make a determination under subsection 204-30(3), including a determination under paragraph 204-30(3)(a).

Questions 10 & 11

The Commissioner has ruled on these questions.