Edited version of private advice

Authorisation Number: 1051983718762

Date of advice: 30 May 2022

Ruling

Subject: Business/share buy-back

Question 1

Will the dividend component of the payment for the Taxpayer's shares under the off-market share buy-back be a fully franked dividend?

Answer

Yes

Question 2

Will the taxpayer be entitled to the franking credit attached to the payment for its shares under the off-market share buy-back?

Answer

Yes

This ruling applies for the following period:

Year ending 30 June 2022

The scheme commences on:

1 July 2021

Relevant facts and circumstances

ABC Pty Ltd as trustee for the DEF Trust (You) are an Australian resident discretionary trust.

You have held the shares in GHI Pty Ltd (the company) since its incorporation.

You do not have carry forward losses.

You have made a family trust election.

The Company

GHI Pty Ltd (the company) is an Australian resident company.

The company has on issue ordinary and O class shares.

You hold 50% of the ordinary shares.

The total paid up capital on the ordinary shares is $X.

The shareholders are unrelated parties.

The company's franking credit balance was $XXX prior to the buy-back.

Background

In the 2021 year, the directors of the company sought offers from third parties to buy the business of the company and engaged an expert to value the company.

An offer was received from a private equity firm.

The shareholders were divided on the offer to sell. One wished to proceed with the sale, the other preferred to retain ownership and continue to grow the business.

The shareholders ultimately could not agree and the sale did not go ahead.

You still wished to realise some of your investment in the company.

The off-market share buy-back

In the relevant income year, the company resolved to undertake a share buy-back of some ordinary shares from you.

The Directors of the Company and the shareholders determined the current enterprise value of the company based on market feedback and done in accordance with ATO market valuation principles.

A report commissioned by the shareholders completed by an expert has determined the company's current market value.

The buy-back was completed in the year ending 30 June 2022 with the consideration payable (the buy-back payment) based on the agreed market value.

The consideration for the buy-back in the accounts of the company is as follows:

(a)          Share capital debited by $1 per ordinary share; and

(b)          Retained earnings debited by the remaining buy-back payment amount.

The company had sufficient franking credits to fully frank the buy-back payment at a franking percentage of 25%.

The company has cancelled the shares in accordance with section 257H(3) of the Corporations Act 2001.

The shareholders are Australian residents and have no tax advantaged shareholders.

Relevant legislative provisions

Income Tax Assessment Act 1936 Division 16K

Income Tax Assessment Act 1936 section 159GZZZK

Income Tax Assessment Act 1936 section 159GZZZP

Income Tax Assessment Act 1936 section 160APHL

Income Tax Assessment Act 1936 section 160APHO

Income Tax Assessment Act 1936 Division 1A of former Part IIIAA

Income Tax Assessment Act 1997 section 202-40

Income Tax Assessment Act 1997 section 202-45

Reasons for decision

Question 1

Will the dividend component of the payment for the Taxpayer's shares under the off-market share buy-back be a fully franked dividend?

Law Administration Practice Statement PSLA 2007/9 provides guidance on applying taxation law in connection with on-market and off-market share buy-backs.

Share buy-backs are mainly governed, for taxation purposes, by Division 16K of Part III of the Income Tax Assessment Act 1936 (ITAA 1936). Division 16K applies where a company buys a share in itself from a shareholder and cancels the share. On-market and off-market share buy-backs are defined in section 159GZZZK of the ITAA 1936. If the share is listed on a stock exchange and the purchase is made in the ordinary course of business of that stock exchange, the buy-back will be an on-market purchase. All other buy backs are treated as off-market purchases for taxation purposes (paragraph 28 PSLA 2007/9).

For the shareholder in an off-market buy-back, so much of the buy-back price that exceeds the part of that price that is debited against the company's share capital account is treated as a dividend paid to the shareholder of the company (section 159GZZZP of the ITAA 1936).

In this case the shares are not listed on a stock exchange and are have been bought back by the company at its market value, the buy-back payment will be $X per share, with $1.00 per share being debited against the company's share capital account, therefore the difference of these amounts is treated as a dividend.

Section 202-40 of the Income Tax Assessment Act 1997 (ITAA 1997) provides that a distribution will be frankable distribution to the extent that it is not unfrankable under section 202-45 of the ITAA 1997.

A distribution is unfrankable pursuant to subsection 202-45(c) of the ITAA 1997, in the case of a share buy-back by a company, to the extent of the excess that the purchase price (buy-back payment) exceeds what would be the market value of the share at the time of the buy-back (section 159GZZZP(1) of the ITAA 1936). As the buy-back payment is equal to the market value of the company, there is no excess and therefore the payment is not an unfrankable distribution.

Conclusion

Subject to the integrity rules, the buy-back payment less the amount debited against the company's share capital account (being $1.00 per share) will be a fully frankable distribution under section 202-40 of the ITAA 1997.

Question 2

Will the taxpayer be entitled to the franking credit attached to the payment for its shares under the off-market share buy-back?

In relation to shares acquired on or after 1 July 1997, a taxpayer must be a 'qualified person' in relation to a dividend in order to be entitled to a tax offset in respect of the franking credits attached to dividends.

A taxpayer is a qualified person for the purposes of Division 1A of former Part IIIAA of the ITAA 1936 if they satisfy the holding period rule and/or the related payments rule.

Holding period rule

The holding period rule in section 160APHO of the ITAA 1936 requires a shareholder to have held their shares 'at risk' for a continuous period (excluding the day of acquisition and the day of disposal if they are disposed) of at least 45 days during the relevant qualification period in order to qualify for a franking benefit.

For a discretionary trust, a beneficiary is taken to hold their interest in the shares held by the Trust in the same way in which shares are held the beneficiary directly.

The related payment rule does not apply in this circumstance as there is no obligation to pass the benefit of the dividend to another party.

Family Trust

Under former section 160APHL of the ITAA 1936, the rules for determining a beneficiary's interest in shares held by a trust were such that dividends received as part of a discretionary trust distribution generally would not qualify for franking credits unless the Trustee of the discretionary trust has made a family trust election.

As you are a discretionary trust that has made a family trust election and you have held the shares for longer than the holding period you are entitled to the franking credit attached to the payment for its shares under the off-market share buy-back.