Edited version of private advice

Authorisation Number: 1051994494933

Date of advice: 14 June 2022

Ruling

Subject: Off market share buy-back

Question 1

Does the buy-back constitute an off-market share buy-back for the purposes of Division 16K of the ITAA 1936?

Answer

Yes.

Question 2.

Is the part of the purchase price (if any) taken to be a dividend paid by the company in accordance with section 159GZZZP of the ITAA 1936 (ie the dividend component) equal to $X?

Answer

Yes.

Question 3.

Will subsection 202-45(c) of the ITAA 1997 apply in respect of the dividend component of the buy-back?

Answer

No.

Question 4.

Will the dividend component of the buy-back be subject to dividend withholding tax if paid to A Co's non-resident shareholders under subsections 128B(1) and (4) of the ITAA 1936?

Answer

Yes.

Question 5.

Will the Commissioner make a determination under paragraph 204-30(3) 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 paragraph 177EA(5)(a) of the ITAA 1936 that a franking debit arises in respect of the buy-back?

Answer

No.

This ruling applies for the following period:

Year ended 30 June 20XX

The scheme commences on:

20 May 20XX

Relevant facts and circumstances

A Co Pty Ltd (A Co) is a private company incorporated in Australia on X July 20XX.

The Group has operations in Australia and New Zealand.

An election was made by A Co to form an income tax consolidated group with its wholly-owned Australian subsidiaries on XX October 20XX. A Co is the head entity in the Australian tax consolidated group.

Financial Information

As at 31 December 20XX (FYXX), the final consolidated financial position of A Co, as disclosed in its consolidated statutory accounts, was as follows:

•         Number of ordinary shares on issue: X;

•         Value of ordinary shares as reflected in the Contributed Equity account: $X;

•         Retained profits balance: $X (profit distribution reserve); and

•         Franking account balance as at 31 December 20XX: $Nil.

The Contributed Equity account of A Co represents a share capital account for income tax purposes on the basis that the first amount credited to that account was an amount of share capital (arising from the issue of an ordinary share). The Contributed Equity account of A Co is not tainted for income tax purposes in accordance with Division 197 of the ITAA 1997.

Dividend Policy

A Co made two dividend payments in the year ended 31 December 20XX (FYXX) totalling $Xm. The first dividend payment of $Xm was paid on XX June 20XX, and comprised a franked component of approximately $Xm and an unfranked component of approximately $Xk. The second dividend payment of $Xm was paid on XX December 20XX, and comprised a franked component of approximately $Xm and an unfranked component of approximately $Xk.

FYXX is the first year in which A Co paid a dividend to its shareholders since 20XX. In 20XX B Co paid a dividend of $Xm.

No dividends were paid across the 20XX to 20XX years due to the need to reinvest any surplus operating cash into the working capital of the business, and to fund its debt repayments.

For FYXX, A Co made the following unfranked dividend payments totalling $Xm:

•         First quarter of 20XX: $Nil.

•         Second quarter of 20XX: $Xm.

•         Third quarter of 20XX: $Xm.

•         Fourth quarter of 20XX: $Xm.

A Co expects to make approximately $Xm of dividend payments during the upcoming year ending 31 December 20XX (FYXX).

Shareholdings

A Co had X fully paid-up ordinary shares on issue as at 31 December 20XX.

No additional shares have been issued by A Co since 31 December 20XX.

On XX December 20XX C Co Pty Ltd (C Co) sold its entire 6.67% shareholding in A Co to the other existing shareholders (i.e. D, E, and F) on a pro-rata basis (C Co Sell-Down) at $X per share (C Co Sale Price).

A Co's shareholder composition outlined in the table below has not changed since the C Co Sell-Down and the composition is not expected to change materially after the date of this ruling (other than as impacted by the Buy-Back)

Objectives of Buy-Back

A Co's key commercial driver for the Buy-Back is to lower its overall cost of capital by increasing the amount of its debt funding (which is cheaper than equity capital provided by its shareholders) by increasing the debt limit under the Amended Syndicated Facility Agreement (SFA) (Refinance)

The debt limit provided under the Syndicated Facility Agreement as amended on XX December 20XX (Amended SFA) is approximately $Xm (20XX Debt Limit). The 20XX Debt Limit is based on financial covenant ratios outlined in the Amended SFA.

A Co's overall cost of capital is suboptimal because it is based on A Co's debt capacity as determined under the Amended SFA, which provides for a lower proportion of debt funding than is desirable from a cost of funding perspective and for which the business can currently sustain.

Based on A Co's recent engagement with the syndicate, the debt limit provided under the Syndicated Facility Agreement as amended on XX December 20XX has increased to $XXm (New Debt Limit). The new Debt Limit is based on the following financial covenant ratios:

•         A DSCR of 1.20:1 (which is unchanged from that provided under the Amended SFA).

•         A debt to EBITDA ratio of 7.50:1 (which is significantly higher from that provided under the Amended SFA).

The New Debt Limit provides an additional $Xm to be drawn down under the syndicated facility after accounting for costs associated with the refinance and other drawdowns to repay existing loans. The New Debt Limit also provides for a $X million CAPEX facility (currently undrawn) and a $X million working capital facility (currently undrawn). The vast majority of the additional $Xm will be used by A Co to fund the Buy-Back.

The Buy-Back

A Co will offer to buy-back $Xm of the ordinary shares on issue (35m ordinary shares) based on a price of $X per share (Buy-Back Price), and offer the Buy-Back to all shareholders equally.

Participation in the Buy-Back will be entirely voluntary. All shareholders are expected to participate in the Buy-Back in order to maintain their percentage ownership in A Co. The Buy-Back is an 'equal access scheme' within the 10/12 limit (s257B Corporations Act 2001) as the Buy-Back is being offered to all shareholders on the same terms and no more than 10% of voting shares are being acquired. Therefore, shareholder approval is not required.

The Buy-Back Price is the market value of the A Co shares acquired under the Buy-Back. This is equal to the C Co Sale Price agreed between arm's length parties as part of the C Co Sell-Down transaction that was completed on XX December 20XX. That is, the market value of A Co's shares for the purposes of the Buy-Back is the price agreed between unrelated parties C Co, and A Co's other shareholders, which was struck on an arm's length basis between willing but not anxious buyers, and a willing but not anxious vendor.

A Co will apply the Commissioner's preferred methodology of Average Capital Per Share (ACPS) as outlined in Practice Statement Law Administration (PS LA) 2007/9. Applying this methodology with reference to the 31 December 20XX statutory accounts, the Buy-Back Price per share will be comprised of:

•         A return of capital of $X per share (debited to A Co's share capital account on the completion of the Buy-Back) (the Capital Component); and

•         The balance of the Buy-Back Price ($X per share) will be debited to A Co's retained earnings (the Dividend Component).

•         A Co will pay the consideration for the Buy-Back in one tranche in June 2022 (Payment Date).

•         All shares bought back under the Buy-Back will be cancelled immediately after completion of the Buy-Back.

•         Based on A Co's franking account balance at 31 December 20XX of $Nil, A Co does not intend to frank any part of the Dividend Component of the Buy-Back.

Relevant legislative provisions

Division 16K Income Tax Assessment Act 1936

Section 159GZZZK Income Tax Assessment Act 1936

Section 159GZZZP Income Tax Assessment Act 1936

Section 159GZZZQ Income Tax Assessment Act 1936

Section 177EA Income Tax Assessment Act 1936

Section 128B Income Tax Assessment Act 1936

Section 44 Income Tax Assessment Act 1936

Section 45A Income Tax Assessment Act 1997

Section 45B Income Tax Assessment Act 1997

Section 45C Income Tax Assessment Act 1997

Section 204-30 Income Tax Assessment Act 1997

Section 100-25 Income Tax Assessment Act 1997

Division 104 Income Tax Assessment Act 1997

Reasons for decision

Question 1

Summary

The buy-back is an off-market share buy-back for the purposes of Division 16K of the ITAA 1936.

Detailed reasoning

Division 16K of the ITAA 1936 applies where a company buys a share (or a non-share equity) 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.

Question 2

Summary

The buy-back price of $X per share will include $X per share (calculated in accordance with the ACPS (average capital per share) method) to be debited against A Co's Contributed Equity account, being a share capital account. The difference between the buy-back price and the capital component, namely $X, will be taken to be a dividend

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.

One method used to determine the 'split' is for the company to work out its average capital per share (ACPS). This is obtained by dividing a company's ordinary issued capital by the number of shares on issue. The amount so derived is a reasonable estimate of any capital component of the split. The balance of any buy-back price would be a dividend.

A Co's Contributed Equity account represents a share capital account for income tax purposes The ACPS method is the ATO's preferred methodology for determining the dividend / capital split in an off-market share buy-back (see paragraph 12 of PS LA 2007/9) and the ACPS should, prima facie, be applied to determine the capital component in an off-market share buy-back. A Co intends to apply the ACPS method to determine the dividend / capital split for the buy-back.

There have been no recent changes to the financial position of A Co, for example capital injections, that would require further examination of the validity of the ACPS method to the buy-back.

Question 3

Summary

The buy-back price has been set at market value by A Co. As the purchase price on the buy-back of a share does not exceed the market value, the dividend component of the buy-back will be frankable.

Detailed reasoning

Under s202-45(c) ITAA 1997, 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 ITAA 1936, 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 will be unfrankable.

The buy-back price set by A Co does not exceed the market value. Further, A Co does not intend to frank any part of the dividend component of the buy-back.

Question 4

Summary

Non-resident shareholders are liable to pay Australian withholding tax on any unfranked dividends they receive from an Australian company.

Detailed reasoning

Under s128B(1) and (4) ITAA 1936 a final withholding tax is imposed on dividends paid by a resident company to non-residents regardless of whether the dividends are income according to ordinary concepts, unless an exception applies.

The franked dividend exception under 128B(3) ITAA 1936 will not apply in this case as A Co will not be franking the dividend component of the share buy-back.

Question 5

Summary

The Commissioner will not make a determination under paragraph 204-30(3) of the ITAA 1997 that a franking debit arises in respect of the buy-back. A Co will not be franking the dividend component of the buy-back and no shareholders will receive franking credits under the buy-back.

Detailed reasoning

Subsection 204-30(1) of the ITAA 1997 provides that the Commissioner has discretion to make determinations where an entity streams one or more distributions such that:

•         an imputation benefit would be received by a member of the entity as a result of the distribution(s)

•         that member would derive a greater benefit from franking credits than another member of the entity, and

•         the other member will receive lesser (or nil) imputation benefits.

For streaming to occur, a member better able to benefit from imputation credits must receive one or more imputation benefits. 'Imputation benefit' is defined in subsection 204-30(6) of the ITAA 1997 as:

•         a entitlement to a tax offset or, if the member is a corporate tax entity, a franking credit

•         an amount that would be included in the members assessable income as a result of the distribution because of the operation of section 207-35 of the ITAA 1997, or

•         an exemption from withholding tax (relevant if the member is a non-resident).

A Co will not be franking the dividend component of the buy-back and the shareholders will not receive an imputation benefit in accordance with subparagraph 204-30(6) of the ITAA 1997. Accordingly, subparagraph 204-30(1) of the ITAA 1997 would not be satisfied.

Question 6

Summary

The Commissioner will make not make a determination under paragraph 177EA(5)(a) of the ITAA 1936 that a franking debit arises in respect of the buy-back as the dividend component of the buy-back will not be franked by A Co and would not be considered a scheme for conferring an imputation benefit.

Detailed reasoning

Section 177EA ITAA 1936 is a general anti-avoidance provision that applies to a wide range of schemes to obtain a tax advantage in relation to imputation benefits. Broadly, 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 an off-market share buy-back with a franked dividend component.

A Co will not be franking the dividend component of the buy-back. Having regard to the relevant circumstances of the buy-back, it would not be concluded that, there is a purpose more than merely an incidental purpose of conferring an imputation benefit under the scheme.