Edited version of private advice

Authorisation Number: 1051979076911

Date of advice: 20 May 2022

Ruling

Subject: Off-market share buy-back

Question 1

Will the Commissioner make a determination pursuant to paragraph 204-30(3)(a) of the Income Tax Assessment Act 1997 (ITAA 1997) in respect of the franking account of Company A in relation to the off-market share Buy-Back?

Answer

No.

Question 2

Will the Commissioner exercise his discretion to make a determination under paragraph 177EA(5)(a) of the Income Tax Assessment Act 1997 (ITAA 1936) that a franking debit arises in the franking account of Company A in respect of franked dividends paid as part of the off-market share buy-back?

Answer

Yes.

Question 3

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

Answer

Yes.

Question 4

Will Company A be entitled to a deduction pursuant to section 230-15 of the ITAA 1997 in respect of interest on borrowings to fund payment of the off-market share buy-back?

Answer

Yes.

Question 5

Will the Commissioner make a determination pursuant to subsection 45C(3) of the ITAA 1936 to debit the franking account of Company A in relation to the off-market share buy-back?

Answer

No.

This ruling applies for the following period:

1 July 20XX to 30 June 20XX

The scheme commences on:

DD MM 20XX

Relevant facts and circumstances

1. Company A is an Australian-resident public company listed on the Australian Securities Exchange (ASX).
2. Company A's share capital account (as defined in section 975-300) is not tainted within the meaning of Division 197.
3. On DD MM 202X (First Announcement Date), Company A announced its intention to undertake an off-market share buy-back of Company A shares up to XX million.
4. Company A regularly reviews its capital structure and seeks to achieve a balance between reducing the cost of capital, retaining flexibility of future business development and maintaining a strong financial position.
5. The off-market share buy-back was open to all Company A shareholders that held ordinary shares on DD MM 202X with limited exceptions.
6. Participation in the off-market share buy-back was optional. Therefore, shareholders who did not want to participate were not required to take any action and the number of shares held by each shareholder did not change as a result of the off-market share buy-back.
7. Under the tender process, eligible shareholders could make an offer to sell some or all of their ordinary shares to Company A:

•         at the specified Tender Discount, or

•         by offering to sell their shares as a Final Price Tender (where shares are sold at whatever Buy-Back Price is ultimately determined under the tender process).

8. The Buy-Back Price was subject to two overriding limits:

•         Company A would not buy back shares at a discount greater than 14% applied to the VWAP (rounded up to the nearest cent) of all trades on the ASX, excluding not 'at-market' trades of Company A shares over the five trading days up to and including DD MM 2022, and

•         Company A also set a maximum price above which it would not buy back any shares, that maximum price being 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?

9. All shares bought back under the off-market share buy-back were cancelled.
10. Under the Buy-Back, $XX per share bought back was debited to Company A's share capital account and the balance of the Buy-Back Price (the Dividend Component) was debited to Company A's Retained Earnings account.
11. The Dividend Component of the Buy-Back Price was fully franked.
12. Company A shares do not constitute 'indirect Australian real property interests' as defined in section 855-25.

Relevant legislative provisions

Income Tax Assessment Act 1936 Section 45B

Income Tax Assessment Act 1936 Paragraph 45B(2)(a)

Income Tax Assessment Act 1936 Paragraph 45B(2)(b)

Income Tax Assessment Act 1936 Paragraph 45B(2)(c)

Income Tax Assessment Act 1936 Paragraph 45B(3)(b)

Income Tax Assessment Act 1936 Paragraph 45B(5)(b)

Income Tax Assessment Act 1936 Subsection 45B(8)

Income Tax Assessment Act 1936 Subsection 45B(9)

Income Tax Assessment Act 1936 Section 45C(3)

Income Tax Assessment Act 1936 Subsection 159GZZZQ(2)

Income Tax Assessment Act 1936 Subsection 177D(2)

Income Tax Assessment Act 1936 Section 177EA

Income Tax Assessment Act 1936 Subsection 177EA(3)

Income Tax Assessment Act 1936 Paragraph 177EA(3)(a)

Income Tax Assessment Act 1936 Paragraph 177EA(3)(b)

Income Tax Assessment Act 1936 Paragraph 177EA(3)(c)

Income Tax Assessment Act 1936 Paragraph 177EA(3)(d)

Income Tax Assessment Act 1936 Paragraph 177EA(3)(e)

Income Tax Assessment Act 1936 Subsection 177EA(5)

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(16)

Income Tax Assessment Act 1936 Subsection 177EA(17)

Income Tax Assessment Act 1936 Paragraph 177EA(17)(b)

Income Tax Assessment Act 1936 Paragraph 177EA(17)(c)

Income Tax Assessment Act 1936 Paragraph 177EA(17)(g)

Income Tax Assessment Act 1936 Paragraph 177EA(17)(j)

Income Tax Assessment Act 1936 Subsection 177EA(18)

Income Tax Assessment Act 1936 Subsection 177EA(19)

Income Tax Assessment Act 1997 Section 202-5

Income Tax Assessment Act 1997 Section 202-40

Income Tax Assessment Act 1997 Subsection 204-30(1)

Income Tax Assessment Act 1997 Paragraph 204-30(1)(a)

Income Tax Assessment Act 1997 Paragraph 204-30(1)(b)

Income Tax Assessment Act 1997 Paragraph 204-30(1)(c)

Income Tax Assessment Act 1997 Subsection 204-30(3)

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

Income Tax Assessment Act 1997 Subsection 204-30(6)

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

Income Tax Assessment Act 1997 Subsection 204-30(7)

Income Tax Assessment Act 1997 Subsection 204-30(8)

Income Tax Assessment Act 1997 Paragraph 204-30(8)(a)

Income Tax Assessment Act 1997 Subsection 204-30(9)

Income Tax Assessment Act 1997 Subsection 204-30(10)

Income Tax Assessment Act 1997 Subsection 230-15(2)

Income Tax Assessment Act 1997 Subsection 995-1(1)

Reasons for decision

All legislative references are to the ITAA 1997 unless otherwise indicated.

Question 1

Summary

The Commissioner will not make a determination pursuant to paragraph 204-30(3)(a) of the ITAA 1997 in respect of the franking account of Company A in relation to the off-market share Buy-Back.

Detailed reasoning

Paragraph 204-30(3)(a) specifies the nature of the determination that the Commissioner may make where the conditions in subsection 204-30(1) apply.

Subsection 204-30(1) empowers the Commissioner to make a determination 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.

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.

The dividend component of Company A's off-market share buy-back was a 'distribution' within the meaning given by section 960-120 of the ITAA 1997. Each participating shareholder received an imputation benefit as a result of the distribution because:

(a)  a member is entitled to a tax offset under Division 207 of the ITAA 1997 (subparagraph 204-30(6)(a)) or

(b)  a franking credit would arise in the franking account of the member as a result of the distribution (subparagraph 204-30(6)(c)).

Approximately XX% of Company A's shares are held by non-residents who did not benefit from franking to the same extent as resident shareholders (paragraph 204-30(8)(a)).

The requirements of subsection 204-30(1) are satisfied in respect of Company A's off-market buy-back as:

• 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.
• some, if not most participating shareholders were residents that derived a greater benefit from franking credits for the purposes of paragraph 204-30(1)(b) and subsections 204-30(7) and (8) than other Company A shareholders such as non-resident Company A shareholders (paragraph 204-30(8)(a)), and
• it is reasonable to conclude that the features of the off-market buy-back influenced some if not most non-resident Company A shareholders to choose not to participate in the off-market buy-back, and as a result, these non-resident shareholders did not receive any imputation benefits in respect of the buy-back.

The Commissioner is of the opinion that the off-market share buy-back was unattractive to non-resident shareholders.

Although the conditions in subsection 204-30(1) are met, the Commissioner will not make a determination pursuant to paragraph 204-30(3)(a) on the basis that the Commissioner will, as set out in the detailed reasoning for Question 2, exercise his discretion under section 177EA to make a determination to debit the franking account balance of Company A under paragraph 177EA(5)(a).

Question 2

Summary

The Commissioner will exercise his discretion to make a determination under paragraph 177EA(5)(a) of the ITAA 1936, which Company A will accept, that a franking debit arises in the franking account of Company A in respect of franked dividends paid as part of the off-market share Buy-Back.

Detailed reasoning

Paragraph 177EA(5)(a) of the ITAA 1936 allows the Commissioner to determine whether a franking debit arises to the corporate tax entity (or whether a franking credit is denied to the relevant taxpayer) based on the various factors in section 177EA of the ITAA 1936.

Section 177EA of the ITAA 1936 is a general anti-avoidance provision that applies where one of the purposes (other than an incidental purpose) of the scheme is to obtain a franking credit benefit. 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 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:

a.    a frankable distribution has been paid, or is payable or expected to be payable, to a person in respect of the membership interests; or

b.    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) must each be present (conjunctively). For the Company A off-market buy-back, the conditions of paragraphs 177EA(3)(a) to (d) are satisfied as follows:

(a)   Paragraph 177EA(3)(a) is satisfied as there was a scheme for disposition of membership interests as defined in paragraphs 177EA(14)(b) and (d), as under the off-market share Buy-Back, Company A entered into a transaction that affected the ownership of shares held and disposed of by participating shareholders which were then subsequently cancelled.

(b)   Paragraph 177EA(3)(b) is satisfied as a frankable distribution was paid as part of the off-market share buy-back pursuant to section 202-40, noting that distributions were not unfrankable.

(c)   Paragraph 177EA(3)(c) is satisfied as, pursuant to the definition in section 995-1, a franked distribution arises if the distribution is franked in accordance with section 202-5. The dividend component was fully franked.

(d)   Paragraph 177EA(3)(d) is also satisfied as participating shareholders received an imputation benefit as per the Note to subsection 177EA(16) and as defined in subsection 204-30(6). For present purposes, participating shareholders are members who are entitled to tax offsets under Division 207 (paragraph 204-30(6)(a)).

Paragraph 177EA(3)(e) of the ITAA 1936 requires a conclusion that Company A, its participating shareholders or any other relevant party entered into the off-market share buy-back with a more than incidental purpose of enabling the participating shareholders (each a relevant taxpayer) to obtain an imputation benefit. In arriving at a conclusion as to purpose under paragraph 177EA(3)(e), the Commissioner must have regard to the relevant circumstances of the arrangement which are not exhaustively outlined in subsection 177EA(17) of the ITAA 1936.

The most relevant circumstance for the off-market buy-back in the present case is its greater attraction to resident shareholders who could fully utilise the franking credits compared to non-resident shareholders.

Paragraph 177EA(17)(b) of the ITAA 1936 states:

(b)  whether the relevant taxpayer would, in the year of income in which the distribution is made, or if the distribution flows indirectly to the relevant taxpayer, in the year in which the distribution flows indirectly to the relevant taxpayer, derive a greater benefit from franking credits than other entities who hold membership interests, or have interests in membership interests, in the corporate tax entity;

The meaning of the phrase 'greater benefit from franking credits' is further and not exhaustively set out in subsections 177EA(18) and (19) of the ITAA 1936. For direct distributions such as those which were received by the participating shareholders, the Note following subsection 177EA(19) refers to subsections 204-30(7) to (10).

Subsection 204-30(8) lists the circumstances that apply for Company A participating shareholders. Paragraph 204-30(8)(a) looks to the greater attraction of the imputation benefits attached to the dividend component of the off-market buy-back price to certain resident participating shareholders than compared to non-resident shareholders.

As set out in the Relevant Facts and Circumstances, non-residents hold approximately XX % of Company A shares.

The Commissioner concludes that the terms and conditions of the off-market share buy-back were unattractive to non-resident shareholders.

Paragraphs 177EA(17)(c), (g) and (j) of the ITAA 1936 are also relevant to the off-market share buy-back. These paragraphs state:

...

(c)   whether, apart from the scheme, the corporate tax entity would have retained the franking credits or exempting credits or would have used the franking credits or exempting credits to pay a franked distribution to another entity referred to in paragraph (b);

...

(g)  whether a deduction is allowable or a capital loss is incurred in connection with a distribution that is made or that flows indirectly under the scheme;

...

(j)    any of the matters referred to in subsection 177D(2).

...

Having regard to all the relevant circumstances of the Buy-Back, the Commissioner is of the view that section 177EA of the ITAA 1936 applies to the Buy-Back.

Where section 177EA of the ITAA 1936 applies, the Commissioner has a discretion pursuant to subsection 177EA(5) to make a determination to debit the company's franking account pursuant to paragraph 177EA(5)(a), or to deny the imputation benefit arising to each participating shareholder pursuant to paragraph 177EA(5)(b).

The Commissioner's practice is to apply paragraph 177EA(5)(a) where a buy-back price achieved does not achieve a discount greater than the maximum acceptable level of discount of 14% to the VWAP of the shares for the five days up to and including the Closing Date of the Buy-Back.

Company A did not purchase its shares under the Buy-Back at a discount greater than 14% to the VWAP of the Company A shares for the five days leading up to and including the closing date of the Buy-Back. As a result, the Commissioner will exercise his discretion in such a way as to debit Company A's franking account pursuant to paragraph 177EA(5)(a) of the ITAA 1936.

Question 3

Summary

The Commissioner will make a determination under paragraph 177EA(5)(a) of the ITAA 1936, which Company A will accept, that a franking debit arises in the franking account of Company A in respect of franked dividends paid as part of the off-market share buy-back, calculated in accordance with the following formula:

Detailed reasoning

Following completion of the off-market share buy-back and recognising the acceptable level of discount applied in setting the Buy-Back Price, the Commissioner will exercise his discretion to make a determination to debit the franking account of Company A pursuant to paragraph 177EA(5)(a) of the ITAA 1936.

The Commissioner will calculate the franking debit to Company A's franking account using the above formula as expressed in paragraph 126 of Law Administration Practice Statement PS LA 2007/9 Share Buy-Backs:

Question 4

Summary

Company A is entitled to a deduction pursuant to section 230-15 in respect of interest on borrowings to fund payment of the off-market share Buy-Back.

Detailed reasoning

Subsection 230-15(2) states that:

You can deduct a loss you make from a financial arrangement, but only to the extent that:

(a)   you make it in gaining or producing your assessable income; or

(b)   you necessarily make it in carrying on a business for the purpose of gaining or producing your assessable income.

In paragraph 13 of Taxation Ruling TR 95/25 Income tax: deductions for interest under section 8-1 of the Income Tax Assessment Act 1997 following FC of T v. Roberts; FC of T v. Smith, the Commissioner states that:

... interest on a borrowing by a company may be deductible where the borrowing is used to fund a repayment of share capital to the shareholders in circumstances where the repaid capital was employed as capital or working capital in the business carried on by the company for the purpose of deriving assessable income. ...

Also, paragraph 15 of TR 95/25 states that:

Similarly, interest on a borrowing by a company is likely to be deductible where the borrowing is used to fund the payment of a declared dividend ... to the shareholders in circumstances where the funds representing the dividend are employed as capital or working capital in the business carried on by the company for the purpose of deriving assessable income. ...

Company A borrowed funds externally which will be used in its general pool of working capital to replace other funds which were used to meet the Buy-Back costs.

To the extent that borrowings were used to fund a portion of the off-market share buy-back which comprised both a dividend and capital component, the external borrowings are a 'financial arrangement' for the purposes of the Division 230.

Accordingly, Company A is entitled to a deduction under subsection 230-15(2) for a loss arising from an interest payment on the basis there is a connection or nexus between the interest payment and Company A's income producing activities.

Question 5

Summary

The Commissioner will not make a determination pursuant to subsection 45C(3) of the ITAA 1936 to debit the franking account of Company A in relation to the off-market share Buy-Back.

Detailed reasoning

In considering whether the Commissioner will make a determination pursuant to subsection 45C(3) to debit the franking account of Company A, the Commissioner must consider the conditions set out in subsection 45B(2) of the ITAA 1936.

Section 45B of the ITAA 1936 applies where:

• there is a scheme under which a person is provided with a capital benefit by a company (paragraph 45B(2)(a)), and
• 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 (paragraph 45B(2)(b)), and
• 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 (paragraph 45B(2)(c)).

The Buy-Back constitutes a 'scheme' within the meaning given by subsection 995-1(1). As set out in the relevant facts and circumstances above, participating shareholders were 'provided with a capital benefit' under the Buy-Back in the form of a distribution of share capital (paragraph 45B(5)(b) of the ITAA 1936). As a result, the requirements of paragraph 45B(2)(a) of the ITAA 1936 are satisfied in respect of the Buy-Back.

Broadly, a participating shareholder 'obtains a tax benefit' under the Buy-Back if the amount of tax payable by a participating shareholder in respect of the capital component of the off-market share 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).

The determination of whether a participating shareholder obtained a relevant tax benefit in respect of the capital component of the off-market share buy-back requires consideration of each participating shareholder's particular circumstances on a case-by-case basis. Company A's shares are held by a wide variety of shareholders. As a result, it is possible that certain participating shareholders may have obtained a tax benefit under the Buy-Back and the requirements of paragraph 45B(2)(b) may be 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 a participating shareholder entered into or carried out the Buy-Back for a more than incidental purpose of enabling a participating shareholder 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 a participating shareholder entered into or carried out the Buy-Back for a more than incidental 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, being the return of surplus capital funds released following a number of business initiatives including actively reducing working capital, disposing of surplus assets and limiting capital expenditure.

Therefore, section 45B of the ITAA 1936 will not apply to the Buy-Back. Accordingly, the Commissioner will not make a determination under paragraph 45B(3)(b) of the ITAA 1936 that section 45C of the ITAA 1936 applies to the whole, or a part, of the capital benefit provided under the off-market share buy-back.