Edited version of private advice

Authorisation Number: 1051994498097

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 and the amount of the franking credit attached be assessable in the hands of A Co's Australian resident shareholders under subsection 44(1) of the ITAA 1936?

Answer

Yes.

Question 5

Will the Commissioner make a determination under section 45A of the ITAA 1936 or section 45B of the ITAA 1936 that section 45C(3) of the ITAA 1936 will apply in respect of the capital component of the buy-back?

Answer

No.

Question 6

Will Capital Gains Tax (CGT) Event A1 happen to the shareholders upon entering into the buy-back pursuant to section 104-10 of the ITAA 1997?

Answer

Yes.

Question 7

Will subsection 159GZZZQ(2) of the ITAA 1936 apply in respect of the buy-back?

Answer

No.

Question 8.

Is the 'reduction amount' for the shareholders in respect of the buy-back pursuant to subsection 159GZZZQ(3) of the ITAA 1936 and subsection 159GZZZQ(4) of the ITAA 1936 equal to $X?

Answer

Yes.

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.

FY20 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 20XX (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

The dividend component of the share buy-back will be taken to be a dividend paid by A Co and assessable to Australian resident shareholders under s44(1) ITAA 1936.

Detailed reasoning

Section 159GZZZP ITAA 1936 provides that where a company undertakes an off-market share buy-back, the difference between the purchase price and the part debited against the company's share capital account is taken to be a dividend paid by the company out of profits on the date the buy-back occurs.

The dividend component of the buy-back will be paid in the income year ended 30 June or 31 December 20XX, and A Co's Australian resident shareholders will be required to include this amount in their assessable income in the year ended 30 June or 31 December 20XX pursuant to subsection 44(1) of the ITAA 1936.

A Co does not intend to frank the dividend component of the buy-back price.

Question 5

Summary

The Commissioner will not make a determination under section 45A or section 45B that section 45C(3) of the ITAA 1936 will apply in respect of the capital component of the buy-back. The split between the capital and dividend of the share buy-back price has been determined by the ACPS (average capital per share method).

Detailed reasoning

Section 159GZZZP of the ITAA 1936 prescribes that 'capital' is debited against the company's share capital account, and the balance of the purchase price is a dividend.

Section 45A of the ITAA 1936 applies where a company streams the provision of capital benefits and the payment of dividends in such a way that capital benefits are received by 'advantaged shareholders' who thereby derive a greater benefit from the capital benefits than other shareholders (who 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.

Although a capital benefit will be provided to the participating shareholders under the buy-back, the circumstances of the buy-back 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 and the dividend component of the buy-back based on the shares sold.

Section 45B of the ITAA 1936 applies where a 'capital benefit' is provided under a scheme for a 'more than incidental purpose' of conferring a tax benefit. Subsection 45B(5) provides that the provision of a 'capital benefit' includes a distribution of share capital. Subsection 45B(9) provides that a capital benefit constitutes a tax benefit in the hands of the shareholder because it is less onerous tax-wise than a dividend.

In accordance with PS LA 2007/9 ACPS gives rise to a strong presumption that sections 45A and 45B of the ITAA 1936 would not apply to the buy-back.

Having regard to the relevant circumstances of the buy-back the Commissioner considers that neither A Co or the participating shareholders will enter into the scheme for more than an incidental purpose of enabling a participating shareholder to obtain a tax benefit. Specifically,

•         A Co as adopted the ACPS method to calculate the capital component of the buy-back;

•         The capital component represents a return of shareholder capital with the commercial intention to lower the overall cost of capital by increasing debt funding and optimise the cost of capital;

•         The buy-back will not alter A Co's dividend policy;

•         The buy-back shares will be cancelled with a corresponding loss of dividend and voting rights.

Therefore, the paragraph 45B(2)(c) ITAA 1936 requirement is not satisfied and the Commissioner will not make a determination under section 45C ITAA 1936 in respect of the capital component of the buy-back.

Question 6

Summary

CGT Event A1 happen to the shareholders upon entering into the buy-back at the time of entering into the buy-back contract.

Detailed reasoning

Under s104-10 ITAA 1997 CGT event A1 occurs when there is a disposal of a CGT asset. The sale of the shares back to A Co by the shareholders participating in the buy-back arrangement will be CGT event A1 which happens when the contract for the disposal is entered into (s104-10(3) ITAA 1997).

Question 7

Summary

Subsection 159GZZZQ(2) of the ITAA 1936 will not apply in respect of the buy-back as the purchase price for the buy-back is the market value of the shares.

Detailed reasoning

Subsection 159GZZZQ(2) ITAA 1936 applies where the purchase price of a share in an off-market share buy-back is less than its market value. The rule requires that the amount of consideration that a seller is taken to have received is 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.

In effect, the amount of any deemed increase pursuant to the special rule is taken to be a capital receipt and alters the CGT position of the seller (usually decreasing any capital loss otherwise available). Likewise, the amount of any assessable revenue gain would be increased, and any deductible loss decreased, by the difference between the actual consideration and the substituted market value amount.

A Co is using a buy-back price that will be equal to the market value of the shares. Accordingly there should not be any adjustment made to the deemed consideration received by the shareholder pursuant to subsection 159GZZZQ(2) ITAA 1936.

Question 8

Summary

The reduction amount is $X for shareholders participating in the buy-back pursuant to subsection 159GZZZQ(3) ITAA 1936 and subsection 159GZZZQ(4) ITAA 1936. The reduction amount is used by individual shareholders participating in the buy-buy to determine the consideration under s159GZZZQ.

Detailed reasoning

For an off-market buy-back, the capital gain or loss (or assessable gain or loss under the ordinary income provisions where applicable) of the shareholders participating in the buy-back are determined on the basis of the purchase price on the buy-back, subject to modifications under 159GZZZQ.

When determining the gain or disposal either under capital gains tax rules or ordinary income rules, the deemed purchase price is reduced by a "reduction amount". Broadly, the reduction amount will be that part of the purchase price that is a deemed dividend under s 159GZZZP, subject to the application of sections 159GZZZQ(3), (4) and (8).