Edited version of private advice

Authorisation Number: 1052272103032

Date of advice: 19 July 2024

Ruling

Subject: On-market share buy-back - franking debit

Question

Will a franking debit arise for the Company as a consequence of the on-market share buy-back under item 9 of the table in subsection 205-30(1) of the Income Tax Assessment Act 1997?

Answer

Yes.

This ruling applies for the following periods:

The income years ended DD Month 20XX and DD Month 20XY

The scheme commenced on:

In a particular income year

Relevant facts and circumstances

The Company is a public company with its shares listed on the official list of a stock exchange.

Prior to the relevant periods, the Company had one account that it kept of its issued and paid-up capital (Contributed Equity).

Over the course of the relevant periods, the Company bought back and cancelled a number of its shares. The shares were bought over the course of trading on the stock exchange.

The amount of consideration the Company paid to buy back its shares during the relevant periods exceeded the balance of its Contributed Equity account.

In accounting for the buy-back, the Company debited part of the consideration against its Contributed Equity account and the remaining balance was debited against a newly created buy-back reserve account (Buy-back Reserve). This was reflected in the Company's financial statements for the relevant periods.

Relevant legislative provisions

Section 205-30 of the Income Tax Assessment Act 1997

Reasons for decision

All legislative references are to the Income Tax Assessment Act 1997 (ITAA 1997) unless otherwise indicated.

Franking debit arises under item 9 of the table in subsection 205-30(1)

Under item 9 of the table in subsection 205-30(1), if an entity purchases a membership interest in itself, the purchase is an on-market buy-back and the entity is a company, then a franking debit will arise on the day on which the interest is purchased.

Subsection 995-1(1) defines 'on-market buy-back' to mean a purchase that is a buy-back and an on-market purchase for the purposes of Division 16K of Part III of the Income Tax Assessment Act 1936 (ITAA 1936) (Division 16K).

Section 159GZZZJ states that in Division 16K, 'buy-back' and 'on-market purchase' have the meaning given by paragraphs 159GZZZK(a) and 159GZZZK(c) respectively.

Section 159GZZZK states that, for the purposes of Division 16K, where a company buys a share in itself from a shareholder in the company:

(a)  the purchase is a buy-back

(b)  the shareholder is the seller

(c)   if:

(i)  the share is listed for quotation in the official list of a stock exchange in Australia or elsewhere, and

(ii) the buy-back is made in the ordinary course of trading on that stock exchange,

the buy-back is an on-market purchase, and

(d)  if the buy-back is not covered by paragraph (c) - the buy-back is an off-market purchase.

The Company's share buy-back is an 'on-market buy-back' as defined in subsection 995-1(1) because:

•      the Company is a company that has bought shares in itself from its shareholders

•      the Company's shares are listed for quotation on the stock exchange, and

•      the buy-back was made in the ordinary course of trading on the stock exchange.

Accordingly, item 9 of the table in subsection 205-30(1) applies to the Company.

The franking debit amount of the buy-back

Where item 9 of the table in subsection 205-30(1) applies, the franking debit that arises in the entity's franking account is an amount equal to the debit that would have arisen if:

(a)  the purchase of the interest were a frankable distribution equal to the one that would have arisen if the entity:

(i)  purchased the interest off-market, and

(ii) in the case of a listed public company - were not a listed public company, and

(b)  the distribution were franked at the entity's benchmark franking percentage for the franking period in which the purchase was made, or if the entity does not have a benchmark franking percentage for the period, at a franking percentage of 100%.

Under subsection 159GZZZP(1) of the ITAA 1936, the difference between the purchase price of an off-market share buy-back and any part of the buy-back that is debited against amounts standing to the credit of the company's share capital account is taken to be a dividend paid by the company.

Therefore, any amount of the buy-back that is debited against the Company's share capital account is not taken to be a dividend for the purposes of the ITAA 1936 or the ITAA 1997 and no franking debit would arise under item 9 of the table in subsection 205-30(1) for such amount - this is because a distribution that is sourced from a company's share capital account is unfrankable under subsection 202-45(e).

Meaning of 'share capital account'

Subsection 975-300(1) provides that a company's 'share capital account' is:

(a)  an account that the company keeps of its share capital; or

(b)  any other account (whether or not called a share capital account) that satisfies the following conditions:

(i)  the account was created on or after 1 July 1998;

(ii) the first amount credited to the account was an amount of share capital.

If a company has more than one share capital account, those accounts are taken, for the purposes of the ITAA 1936 and the ITAA 1997, to be a single account (subsection 975-300(2)).

The concept of share capital is not defined in the ITAA 1997 and takes its ordinary meaning.

Share capital includes amounts received by a company in consideration for the issue of shares. In Archibald Howie Pty Ltd v Commissioner of Stamp Duties (NSW) [1948] HCA 28 (Archibald), Williams J said:

A company obtains capital by the issue of its shares...The amount payable may be satisfied by the payment of money or by some other proper consideration. But all shares must be paid for in full by money or money's worth. When the person to whom the shares are allotted pays or assumes the liability to pay for the shares in money or money's worth, full consideration in money or money's worth moves from him to the company for all the rights which he acquires under the memorandum and articles of association.

Also in Archibald, Dixon J said:

From the standpoint of company law the division of the capital of a company into shares and the payment up of shares issued are regarded as respectively significant and real. The shareholder contributes the amount of the share to the capital of the company. This contribution measures his right to any return of capital which the company may make either as a going concern or in a winding up.

In Re The Swan Brewery Co Ltd (1976) 3 ACLR 164, Gillard J said:

But when one talks about share capital, in my view, it means capital raised by the company from the issue of its shares.

This was supported in St. George Bank Ltd v Commissioner of Taxation [2009] FCAFC 62 where Perram J (with whom Emmett and Stone JJ agreed) said:

The 'capital' of the company is the money or money's worth derived by the company from the issue of shares.

Whether an account is one that a company keeps of its share capital requires a factual inquiry as demonstrated in Commissioner of Taxation v Consolidated Media Holdings Ltd [2012] HCA 55 (Consolidated Media), and Cable & Wireless Australia & Pacific Holding BV (in liquidatie) v Commissioner of Taxation [2017] FCAFC 71 (Cable & Wireless).

The Company recorded its issued and paid-up capital in its Contributed Equity account. Therefore, the Contributed Equity account is an account that the Company keeps of its share capital and is a 'share capital account' within the meaning given in section 975-300. The amount of the buy-back consideration that is debited against this account is not taken to be a dividend under subsection 159GZZZP(1) of the ITAA 1936 and is excluded when working out the amount of the franking debit that is to arise under item 9 of the table in subsection 205-30(1).

The Company does not record its issued and paid-up capital in its Buy-back Reserve account.

The Company's circumstances are substantially different to those in Consolidated Media. Instead, the Company's circumstances are, in substance, identical to those in Cable & Wireless.

Accordingly, the Buy-back Reserve account is not an account that the Company keeps of its share capital (paragraph 975-300(1)(a)). As paragraph 975-300(1)(b) is also not applicable (because no amounts - share capital or otherwise - were credited to the Buy-back Reserve account), the Buy-back Reserve account is not a 'share capital account' within the meaning of section 975-300.

Therefore, any amount of the buy-back consideration that is debited against the Buy-back Reserve account is taken to be a dividend paid by the Company under subsection 159GZZZP(1) of the ITAA 1936.

In working out the amount of any franking debit under item 9 of the table in subsection 205-30(1), such notional dividends will be treated as franked to the Company's 'benchmark franking percentage' (as defined in subsection 203-10(1)) for the relevant periods.