Edited version of private advice

Authorisation Number: 1051920570826

Date of advice: 10 November 2021

Ruling

Subject: Off market share buy-backs

Question 1

Will the equal access buy-back and selective share buy-back (together, the 'buy-backs') each be an off-market purchase within the meaning given by subsection 159GZZZK(d) of the Income Tax Assessment Act 1936 (Cth) (ITAA 1936)?

Answer

Yes.

Question 2

Will the buy-backs and subsequent cancellation of any shares bought back be disregarded for the purposes listed in section 159GZZZN of the ITAA 1936?

Answer

Yes.

Question 3

Will the Commissioner accept that the Buy-Back Price represents market value consideration for the shares bought back for the purposes of Division 16K of Part III of the ITAA 1936?

Answer

Yes.

Question 4

Will the amount calculated by the 'average capital per share' (ACPS) methodology represent the capital component of the Buy-Back Price (Capital Component) for the purposes of subsection 159GZZZP(1) of the ITAA 1936?

Answer

Yes.

Question 5

Will the dividend component of the Buy-Back Price (Dividend Component) be taken to be a dividend that is paid out of Co's retained profits under subsection 159GZZZP(1) of the ITAA 1936?

Answer

Yes.

Question 6

Will the Dividend Component be a frankable distribution and therefore capable of being franked pursuant to section 202-40 of the Income Tax Assessment Act 1997 (Cth) (ITAA 1997)?

Answer

Yes.

Question 7

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 any part, of the Capital Component of Buy-Back Price for the shares bought back ?

Answer

No.

Question 8

Will the Commissioner make a determination under paragraph 45B(3)(b) of the ITAA 1936 that section 45C of the ITAA 1936 applies in relation to the whole, or any part, of the Capital Component of the Buy-Back Price for the shares bought back ?

Answer

No.

Question 9

Will the Commissioner make a determination under paragraph 204-30(3)(a) of the ITAA 1997 that a franking debit arises in the franking account of Co in relation to the buy-backs?

Answer

No.

Question 10

Will the Commissioner make a determination under paragraph 177EA(5)(a) of the ITAA 1936 to apply a franking debit to Co's franking account in relation to the Dividend Component of the Buy-Back Price for the shares bought back?

Answer

No.

Question 11

Will the equal access buy-back scheme and/or the selective buy-back scheme give rise to a direct value shift under Division 725 of the ITAA 1997?

Answer

No.

This ruling applies for the following period:

30 June xx

The scheme commences on:

A specified date

Relevant facts and circumstances

Co Limited (Co) is an unlisted public company.

As at 30 June 20xx, Co had x ordinary shares on issue.

All of Co's shareholders are Australian resident companies.

The financial statements of Co as at 30 June 20xx show issued share capital of $x million and retained earnings of $x million.

Co was the founding investor in Holdings Ltd (Holdings). Holdings was established as a wholly owned subsidiary of Co. The sole source of funding for this investment was shareholder funds.

On DD MM 20xx, Co disposed of its interest in Holdings for approximately $x million.

Off-market share buy-backs

On DD MM 20xx (Announcement Date), Co announced it proposed to distribute a substantial portion of the Holdings sale proceeds to shareholders in the form of two buy-backs:

•         an equal access buy-back offer to all shareholders (to acquire up to x% of the issued capital) for up to $x million, and

•         a selective buy-back offer to certain shareholders that each held less than x% of Co shares, for all their Co shares (to acquire up to x% of the issued capital) for up to $x million

•         (together, referred to in this ruling as the 'buy-backs')

Shareholders approved the selective buy-back at the Annual General Meeting (AGM). The equal access buy-back did not require shareholder approval but would only proceed if shareholders approved the selective buy-back.

Co advised that the commercial rationale for the equal access buy-back was to return to Co shareholders part of the profit and share capital released from the disposal of Holdings. The commercial rationale for the selective buy-back was to provide minor Co shareholders with an opportunity to realise their investment in Co.

The price offered per share for each of the buy-backs was a fixed price of $x per share (Offer Price), made up of $x Capital Component and $x Dividend Component.

Co proposed to fully frank the dividend component of the Offer Price.

Participation in the buy-backs was voluntary and therefore Co shareholders who did not wish to participate were not required to do anything.

Co also announced it would pay a fully franked special dividend to all shareholders of x cents per share ('special dividend') and a fully franked ordinary dividend of x cents per share ('FY 20xx Dividend') on DD MM 20xx.

A summary of the key dates for the equal access buy-back and selective buy-back was provided.

All Co shares bought back under the equal access buy-back and selective buy-back were cancelled.

The buy-back price was subject to two overriding limits:

•         Co would not buy back its shares at a discount greater than 14% applied to the VWAP of its shares over the last 5 trading days up to the respective Notification of outcome dates for the buy-backs, and

•         Co would not buy back the shares above their market value of $x.

Co shares were subject to a trading halt during the period starting before the buy-back period commenced until after the buy-back was implemented.

Co's share capital account (as defined in section 975-300 of the ITAA 1997), was not tainted within the meaning of Division 197 of the ITAA 1997.

No Co shareholder alone or together with associates held 40% of Co shares; or had rights to 40% of dividends or returns of capital paid by Co, nor in fact controlled Co.

All Co shareholders should be subject to the capital gains provisions in respect of the capital component, as no shares are pre-CGT.

The total of the proposed special dividend and the dividend components of the buy-backs is $x million, which represents a portion of Co's estimated gain after tax disclosed in its profit and loss.

Co does not expect that the special dividend and buy-backs will affect its ability to pay fully franked dividends in the future. Historically, Co has paid interim and final dividends and its normal dividend policy will not be impacted either by the payment of the special dividend or the buy-backs.

Relevant legislative provisions

Income Tax Assessment Act 1936, Division 16K

Income Tax Assessment Act 1936, subsection 159GZZZK(a)

Income Tax Assessment Act 1936, subsection 159GZZZK(d)

Income Tax Assessment Act 1936, section 159GZZZN

Income Tax Assessment Act 1936, subsection 159GZZZN(a)

Income Tax Assessment Act 1936, subsection 159GZZZN(b)

Income Tax Assessment Act 1936, section 159GZZZQ(2)

Income Tax Assessment Act 1936, subsection 159GZZZP(1)

Income Tax Assessment Act 1936, subsection 177EA(3)

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

Income Tax Assessment Act 1936, paragraph 177EA(5)(b)

Income Tax Assessment Act 1936, subsection 177EA(14)

Income Tax Assessment Act 1936, subsection 177EA(17)

Income Tax Assessment Act 1997, section 45A

Income Tax Assessment Act 1997, subsection 45A(2)

Income Tax Assessment Act 1997, paragraph 45A(3)(b)

Income Tax Assessment Act 1997, section 45B

Income Tax Assessment Act 1997, paragraph 45B(2)(b)

Income Tax Assessment Act 1997, paragraph 45B(2)(c)

Income Tax Assessment Act 1997, subsection 45B(9)

Income Tax Assessment Act 1997, section 45C

Income Tax Assessment Act 1997, subsection 45C(3)

Income Tax Assessment Act 1997, section 202-5

Income Tax Assessment Act 1997, section 202-40

Income Tax Assessment Act 1997, subsection 202-45(1)

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

Income Tax Assessment Act 1997, section 204-30

Income Tax Assessment Act 1997, subsection 204-30(1)

Income Tax Assessment Act 1997, subsection 204-30(3)

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

Income Tax Assessment Act 1997, subparagraph 204-30(6)(a)

Income Tax Assessment Act 1997, subparagraph 204-30(6)(c)

Income Tax Assessment Act 1997, section 204-30(8)

Income Tax Assessment Act 1997, Division 725

Income Tax Assessment Act 1997, subsection 725-145(1)

Income Tax Assessment Act 1997, paragraph 725-145(1)(b)

Income Tax Assessment Act 1997, paragraph 725-145(1)(c)

Income Tax Assessment Act 1997, subsection 725-145(2)

Income Tax Assessment Act 1997, subsection 725-145(3)

Income Tax Assessment Act 1997, subsection 995-1(1)

Income Tax Assessment Act 1997, section 960-120

Reasons for decision

Question 1

Summary

The buy-backs are each an off-market purchase within the meaning given by subsection 159GZZZK(d) of the ITAA 1936.

Detailed reasoning

For the purposes of Division 16K of Part III of the ITAA 1936, where a company buys a share in itself from a shareholder, the purchase is a "buy-back" (subsection 159GZZZK(a) of the ITAA 1936).

As per subsection 159GZZZK(c) of the ITAA 1936, a buy-back is an on-market purchase if the share bought back is listed for quotation in the official list of a stock exchange in Australia or elsewhere, and the buy-back is made in the ordinary course of trading on that stock exchange. A buy-back that is not an on-market purchase is an off-market purchase (subsection 159GZZZK(d) of the ITAA 1936).

Co is an unlisted public company and its shares are not listed for quotation in the official list of a stock exchange in Australia or elsewhere.

Accordingly, the buy-backs are each an off-market purchase within the meaning given by subsection 159GZZZK(d) of the ITAA 1936.

Question 2

Summary

Section 159GZZZN of the ITAA 1936 will apply to the buy-backs such that any subsequent cancellation of the shares bought back are disregarded for the purposes described in subsections 159GZZZN(a) and (b) of the ITAA 1936.

Detailed reasoning

Under section 159GZZZN of the ITAA 1936, 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-backs, Co purchased all of the ordinary shares that it accepted on DD MM 20xx (equal access buy-back) and DD MM 20xx (selective buy-back). Co then cancelled those ordinary shares.

As Co bought back its ordinary shares, the buy-backs and the subsequent cancellation of the shares will be disregarded by Col for income tax purposes under section 159GZZZN of the ITAA 1936. Accordingly, an amount will not be included in Co's assessable income or as an allowable deductions, or included in determining whether Co made a capital gain or capital loss.

Question 3

Summary

The Commissioner accepts that the Buy-Back Price for the shares represents market value consideration for the shares bought back for the purposes of Division 16K of Part III of the ITAA 1936.

Detailed reasoning

In accordance with subsection 159GZZZQ(2) of the ITAA 1936, the market value of a Co share purchased under the buy-backs is relevant for determining the amount of consideration that Co shareholders are taken to have received or are entitled to receive in respect of the sale of a share under the buy-backs.

Subsection 159GZZZQ(2) of the ITAA 1936 requires determination of:

...the amount that would have been the market value of the share at the time of the buy-back if the buy-back did not occur and was never proposed to occur.

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) sets out a formula for calculating the market value of shares in a listed company for the purposes of Division 16K of Part III of the ITAA 1936, however, this formula does not apply in the present case as Co's shares are not listed. As per ATO guidance, if a company undertaking a buy-back is unlisted, it should obtain a market valuation of the shares.

Co obtained an independent market valuation, a copy of which was supplied with this private ruling application (the Independent Expert's Report). The Independent Expert's Report supports that a reasonable market value of the Co shares at the time of the equal access and selective buy-backs is $x per share. Co has set its Buy-Back Price for the shares of $x per share on the basis of the Independent Expert's Report. Further, as per the facts, Co provided undertakings that:

• it will not buy back its shares at a discount greater than 14% applied to the VWAP of its shares over the last 5 trading days up to the respective Notification of outcome dates for the buy-backs, and
• it will not buy back the shares above their market value of $x.

The Commissioner accepts the Buy-Back Price of $x per share represents market value consideration for each Co share bought back for the purposes of subsection 159GZZZQ(2) of the ITAA 1936.

Accordingly, the Buy-Back Price represents market value consideration for the Co shares bought back for the purposes of Division 16K of Part III of the ITAA 1936.

Question 4

Summary

The amount debited per share, as calculated by the Average Capital Per Share (ACPS) method, represents the Capital Component for the purposes of subsection 159GZZZP(1) of the ITAA 1936.

Detailed reasoning

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

(1) For the purposes of this Act, but subject to section (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.

As per Question 1, the purchase by Co of its ordinary shares under the each of the buy-backs is an off-market purchase.

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 capital/dividend split in an off-market share buy-back. As per paragraph 62 of PS LA 2007/9, the ACPS method involves dividing a company's ordinary issued capital by the number of shares on issue. The balance of any Buy-Back Price would be a dividend.

Subsection 159GZZZP(1) of the ITAA 1936 provides that the difference between the purchase price and the debit to the amounts standing to the credit of a company's share capital account is taken to be a dividend. Co will debit the amount per share derived from the ACPS method, being x cents per share, to its untainted share capital account.

Therefore, the amount debited per share, as calculated by the ACPS method, represents the Capital Component of the Buy-Back Price (x cents per share) for the purposes of subsection 159GZZZP(1) of the ITAA 1936.

Question 5

Summary

The Dividend Component is taken to be a dividend paid out of Co's retained profits under subsection 159GZZZP(1) of the ITAA 1936

Detailed reasoning

Subsection 159GZZZP(1) of the ITAA 1936 provides that the difference between the purchase price and the debit to the amounts standing to the credit of a company's share capital account is taken to be a dividend. It states that:

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.

Co will debit an amount per share bought back in the buy-backs to its untainted share capital account. As outlined in Question 4, the debit of that amount per share (x cents) represents the Capital Component of the Buy-Back Price. Therefore, the difference per share between the Buy-Back Price and the amount debited to the share capital account is taken to be a dividend.

The Buy-Back Price is $x per share, of which x cents per share is the Capital Component. As a result, the Dividend Component of $x per share is taken to be a dividend paid out of Co's retained profits under subsection 159GZZZP(1) of the ITAA 1936.

Question 6

Summary

The Dividend Component will be a frankable distribution pursuant to section 202-40 of the ITAA 1997.

Detailed reasoning

Section 202-40 of the ITAA 1997 deals with frankable distributions.

The Dividend Component of $x per share constitutes a 'distribution' within the meaning given by table item 1 in subsubsection 960-120(1) of the ITAA 1997 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 subsubsection 159GZZZP(1) of the ITAA 1936.

As per subsection 202-40(1) of the ITAA 1997, a distribution is a frankable distribution to the extent that it is not unfrankable under section 202-45 of the ITAA 1997. However, under paragraph 202-45(c), a distribution is unfrankable to the extent that the buy-back price exceeds the amount that would be 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.

As per Question 3, the Commissioner accepts that the Buy-Back Price is the market value of the shares. As the Buy-Back Price is equal to the market value of the shares, paragraph 202-45(c) of the ITAA 1997 will not apply to the Dividend Component of the Buy-Back Price and in turn subsection 202-40(1) of the ITAA 1997 will operate to treat the entire Dividend Component of the Buy-Back Price as a frankable distribution.

Question 7

Summary

The Commissioner will not make a determination under subsection 45A(2) of the ITAA 1936 that section 45C of the ITAA 1936 applies to the whole, or a part, of the Capital Component of the Buy-Back Price. The Commissioner will therefore not make a further determination under subsection 45C(3) of the ITAA 1936 in respect of Co.

Detailed reasoning

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 Commissioner may make a determination to the effect that section 45C of the ITAA 1936 applies to all or part of a capital benefit. Such a capital benefit is then deemed to be an unfranked dividend.

Shareholders who participate in the buy-backs (Participating Shareholders) will be provided with a capital benefit under the buy-backs as share capital will be distributed to them (paragraph 45A(3)(b) of the ITAA 1936).

Although a capital benefit will be provided to Participating Shareholders under the buy-backs, the circumstances of the buy-backs indicate that there is no streaming of capital benefits to some shareholders that derive a greater benefit from capital benefits and dividends to other shareholders. All participating shareholders will receive both the Capital Component and the Dividend Component based on the number of shares they sell under the buy-backs.

Accordingly, the Commissioner will not make a determination under subsection 45A(2) of the ITAA 1936 that section 45C of the ITAA 1936 applies to the whole, or a part, of the Capital Component of the Buy-Back Price.

Question 8

Summary

The Commissioner will not make a determination under paragraph 45B(3)(b) of the ITAA 1936 that section 45C of the ITAA 1936 applies in relation to the whole, or any part, of the Capital Component of the Buy-Back Price for the shares bought back.

Detailed reasoning

In accordance with paragraph 45B(2)(b) and subsection 45B(9) of the ITAA 1936, a person will obtain a tax benefit under the buy-backs if the amount of tax payable, or any other amount payable under the Act, by the person would be less than the amount that would have been payable, or would be payable at a later time than it would have been payable, if the capital benefit was instead an assessable dividend.

Section 45B of the ITAA 1936 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 (as per subsection 45B(2)):

(a)  there is a scheme under which a person is provided with ... 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 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.

For section 45B of the ITAA 1936 to apply, each of the requirements set out in paragraphs (a), (b) and (c) of subsection 45B(2) of the ITAA 1936 must be present.

The equal access and selective buy-backs will each be a 'scheme' within the meaning given by subsection 995-1(1) of the ITAA 1997. Participating Shareholders will be 'provided with a capital benefit' under the buy-backs as share capital will be distributed to Participating Shareholders under the buy-backs (paragraph 45B(5)(b) of the ITAA 1936). As a result, the paragraph 45B(2)(a) of the ITAA 1936 requirement is satisfied in respect of the buy-backs.

A Participating Shareholder 'obtains a tax benefit' under the buy-backs if the amount of tax payable by that shareholder in respect of the buy-backs is less than the amount of tax that would be payable if the Capital Component of the Buy-back Price was instead an assessable dividend (subsection 45B(9) of the ITAA 1936).

Having regard to the relevant circumstances of the buy-backs set out in subsection 45B(8) of the ITAA 1936, the Commissioner considers that neither Co nor a Participating Shareholder entered into or carried out the buy-backs for a more than incidental purpose of enabling a Participating Shareholder to obtain a tax benefit. In particular, it is noted that

•         Co adopted the ACPS method to calculate the Capital Component and this is not attributable to the profits of Co.

•         The Capital Component represents a partial return of shareholder capital that was previously deployed in the Holdings investment and is no longer required by Co.

•         The buy-backs will not alter Co's dividend policy.

•         The shares held by participating shareholders will be cancelled with a corresponding loss of dividend and voting rights.

Therefore, the paragraph 45B(2)(c) of the ITAA 1936requirement is not satisfied in respect of the buy-backs.

Accordingly, the Commissioner will not make a determination under paragraph 45B(3)(b) of the ITAA 1936that section 45C of the ITAA 1936 applies to the whole, or a part, of the capital benefit provided under the buy-back. It follows that the Commissioner will not make a determination under subsection 45C(3) of the ITAA 1936 in respect of any part of the capital benefit provided under the buy-back.

Question 9

Summary

The Commissioner will not make a determination under paragraph 204-30(3)(a) of the ITAA 1997.

Detailed reasoning

Section 204-30 of the ITAA 1997 gives the Commissioner the power to make a determination when distributions and other benefits are streamed. Subsection 204-30(1) of the ITAA 1997 states:

(1)  This section empowers the Commissioner to make determinations if an entity streams one or more distributions (or one or more distributions and the giving of other benefits), whether in a single franking period or in a number of franking periods, 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 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.

Where the elements in paragraphs (a) to (c) are satisfied, the Commissioner may make one or more of the determinations in subsection 204-30(3) of the ITAA 1997, being:

(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;

(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.

The Dividend Component of the Buy-Back Price will be a "distribution" within the meaning given by section 960-120 of the ITAA 1997.

Relevant to this case, an imputation benefit is received as a result of a distribution under subparagraphs 204-30(6)(a) or (c) if:

a member is entitled to a tax offset under Division 207 of the ITAA 1997; or

a franking credit would arise in the franking account of the member as a result of the distribution.

Each participating Co shareholder will receive an imputation benefit as a result of the distribution.

Subsection 204-30(8) of the ITAA 1997 provides that:

A member of an entity derives a greater benefit from franking credits than another member of the entity if any of the following circumstances exist in relation to the other member in the income year in which the distribution giving rise to the benefit is made, and not in relation to the first member:

(a)  the other members is a foreign resident;

(b)  the other members would not be entitled to any tax offset under Division 207 because of the distribution;

(c)   the amount of the income tax that, apart from this Division, would be payable by the other members because of the distribution is less than the tax offset to which the other member would be entitled;

(d)  the other member is a corporate tax entity at the time the distribution is made, but no franking credit arises for the entity as a result of the distribution;

(e)  the other member is a corporate tax entity at the time the distribution is made, but cannot use franking credits received on the distribution to frank distributions to its own members because:

(i)            it is not a franking entity; or

(ii)           it is unable to make frankable distributions;

(f)    the other member is an *exempting entity.

Streaming is selectively directing the flow of franked distributions to those members who can most benefit from imputation credits. The law uses an essentially objective test for streaming, although purpose may be relevant where future conduct is a relevant consideration. It will normally be apparent on the face of an arrangement that a strategy for streaming is being implemented. The distinguishing of members on the basis of their ability to use franking benefits is a key element of streaming.

The Commissioner concludeded that section 204-30 does not apply and therefore no determination under paragraph 204-30(3)(a) will be made in respect of Co.

Question 10

Summary

The Commissioner will not make a determination under paragraph 177EA(5)(a) of the ITAA 1936 to apply a franking debit to Co's franking account in relation to the Dividend Component of the Buy-Back Price for the shares bought back.

Detailed reasoning

The taxation consequences of a share buy-back are primarily contained in Division 16K of Part III of the ITAA 1936. In an off-market share buy-back the purchase price paid to a shareholder who participates in the buy-back is generally divided into a dividend component and a capital component.

Subsection 159GZZZP(1) of the ITAA 1936 provides that the difference between the purchase price and the part of the purchase price which is debited against amounts standing to the credit of the company's share capital account is taken to be a dividend paid out of profits by the company to the seller on the day the buy-back occurs. The dividend component is a frankable distribution subject to various integrity rules including section 177EA of the ITAA 1936.

Section 177EA is directed at schemes involving franking credit trading and dividend streaming. The reason for its introduction was explained in the Explanatory Memorandum to Act No 47 of 1998 (paragraph 8.124) as follows:

...One of the underlying principles of the dividend imputation system is that the benefits of imputation should only be available to the true economic owners of shares, and only to the extent that those taxpayers are able to use the franking credits themselves. Franking credit trading, which broadly is the process of transferring franking credits on a dividend from investors who cannot fully use them (such as non-residents and tax-exempts) to others who can fully use them undermines this principle. Similarly, dividend streaming (i.e. the streaming of franking credits to select shareholders) undermines the principle that, broadly speaking, tax paid at the company level is imputed to shareholders proportionately to their shareholdings...

The section applies if a scheme involving a disposition of shares is entered into with a purpose of enabling the taxpayer to obtain franking credit benefits. In these circumstances, it enables the Commissioner to deny the franking credit benefits arising from the scheme or, if the company is a party to the scheme, to post a debit to the company's franking account.

Section 177EA of the ITAA 1936 applies if subsection 177EA(3) is satisfied. That is:

(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.

Where the provision applies, the Commissioner may make a determination that a debit arises in the franking account of the corporate tax entity which made the distribution pursuant to paragraph 177EA(5)(a). Alternatively, the Commissioner may make a determination that no imputation benefit arises for the relevant (recipient) taxpayer pursuant to paragraph 177EA(5)(b).

The relevant circumstances indicate that the provision of imputation benefits to the Participating Shareholders will be incidental to the off-market share Buy-backs and section 177EA of the ITAA 1936 does not apply. Accordingly, Commissioner will not make a determination under section 177EA(5)(a) of the ITAA 1936.

Question 11

Summary

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

Detailed reasoning

Division 725 of the ITAA 1997 applies to 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:

(1) 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 sections (2) and (3) are satisfied.

Subsections 725-145(2) and (3) of the ITAA 1997 refer respectively to the issue of an equity or loan interest at a discount, or an increase in the market value of an equity or loan interest in the target entity, reasonably attributable to the thing referred to in paragraph 725-145(1)(b) of the ITAA 1997.

As set out in the Detailed reasoning for Question 3, the Commissioner accepts that $x is the relevant market value of a Co share for the purposes of Division 16K of the ITAA 1997. As there is no decrease in the market value of one or more equity or loan interests in Co, the requirements of subsection 725-145(1) of the ITAA 1997 are not satisfied, nor is there an increase in the market value of one or more equity or loan interests in Co for the purposes of subsection 725-145(3) of the ITAA 1997 (which is necessary for paragraph 725-145(1)(c) of the ITAA 1997). For completeness, the Relevant facts and circumstances do not include Co issuing equity or loan interests at a discount (subsection 725-145(2) of the ITAA 1997).