Edited version of private advice

Authorisation Number: 1052308518903

Date of advice: 25 September 2024

Ruling

Subject: Share buy-back

Question

Is the capital/dividend split for the purposes of section 159GZZZP of the Income Tax Assessment Act 1936 (ITAA 1936) used in relation to a share buy-back undertaken by the Company in acceptable?

Answer

Yes.

This ruling applies for the following period:

Year ended 30 June 20XX

The scheme commenced on:

XX/XX/20XX

Relevant facts and circumstances

1.            All shareholders and former shareholders of the Company are residents of Australia for income tax purposes.

2.            None of the shares of the Company are not listed on an approved stock exchange. It operates an employee share scheme.

3.            The value of the Company's shares is determined in accordance with the valuation formula set out in the Shareholders Agreement. The value determined using this formula is the market value of the Company's shares.

4.            On XX/XX/20XX, an employee purchased shares in the Company under an employee share scheme. The Company credited its Share capital account with the full proceeds from the employee.

5.            On XX/XX/20XX, the Company initiated a buy-back of its shares from an employee and adhered to all the regulatory requirements to buy-back its shares.

6.            The buy-back price per share paid to the employee was slightly greater than what the employee paid for each share. The Company accounted for buy back of the shares by debiting the total consideration paid to the Trust to the Company's 'Share capital account'.

7.            The Company cancelled the shares it acquired from the employee shortly after.

8.            There were no capital injections into the Company shortly before the share buy-back occurred.

Relevant legislative provisions

Income Tax Assessment Act 1936 Division 16K

Income Tax Assessment Act 1936 section 159GZZK

Income Tax Assessment Act 1936 paragraph 159GZZZK(c)

Income Tax Assessment Act 1936 paragraph 159GZZZK(d)

Income Tax Assessment Act 1936 paragraph 159GZZZM(a)

Income Tax Assessment Act 1936 section 159GZZZP

Income Tax Assessment Act 1936 subsection 159GZZZP(1)

Income Tax Assessment Act 1997 Division 83A

Reasons for decision

All legislative references are to the ITAA 1936 unless otherwise stated.

1.            Division 16K prescribes the income tax consequences of a buy-back of shares for the purchaser and seller.

2.            Subsection 159GZZZK(1) states:

For the purposes of this Division, where a company buys a share in itself from a shareholder in the company:

(a) the purchase is a buy back; and

(b) the shareholder is the seller; and

(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.

3.            Accordingly, the arrangement entered into by the Company to acquire shares held in the Company by the employee is a share buy-back for the purposes of paragraph 159GZZZK(1)(a).

4.            Furthermore, pursuant to paragraph 159GZZZK(1)(d) the share buy-back is an off-market buy-back because none of the shares issued by the Company, are listed on an official list of a stock exchange in Australia or elsewhere.

5.            Relevantly paragraph 159GZZM(a) includes the amounts of money the employee has received or is entitled to receive in the 'purchase price' for the purposes of Division 16K.

6.            Subsection 159GZZZP(1) states:

For the purposes of this Act, but subject to subsection (1A), where a buy-back of a share or a non-share equity interest by a company is an off-market purchase, the difference between:

(a)           the purchase price; and

(b)           the part (if any) of the purchase price in respect of the buy-back of the share or non-share equity interest is debited against amounts standing to the credit of:

(i)            the company's share capital account if tit is a share that is bought back; or

(ii)           the company's share capital account or non-share capital account if it is a non-share equity interest that is bought back;

is taken to be a dividend paid by the company:

(c)            to the seller as a shareholder in the company; and

(d)           out of profits derived by the company; and

(e)           on the day the buy-back occurs.

7.              As this share buy-back is an off-market purchase and the Company is proposing to debit the entirety of the purchase price against amount standing to the credit of the Company's 'Share capital account', no part of the purchase price will be taken to be a dividend paid by the company.

8.              Practice Statement Law Administration PS LA 2007/9: Share buy-backs (PS LA 2007/9) provides instruction and practical guidance to staff on the application of various taxation laws in connection with on market and off market buy-backs.

9.            Paragraphs 1 and 2 of the PS LA 2007/9 states:

1. This practice statement is designed to assist tax officers to resolve technical issues in connection with on-market and off-market share buy-backs.

2. Tax officers proposing to provide Administratively Binding Advice, Private Rulings or Class Rulings in connection with share buy-backs should follow this practice statement. However, nothing in this practice statement should be taken to require the exercise of a legal discretion without properly taking into account the particular facts of the case.

10.           Paragraphs 59 of PS LA 2007/9 states:

An essential aspect of any off-market share buy-back is the 'split' between the return of capital and the dividend paid to participating shareholders. Section 159GZZZP prescribes that:

•                     'capital' is debited against the company's share capital account; and

•                     the balance of the purchase price is a dividend.

The 'split' is nominated by the company. However, the ATO will have regard to the various anti-avoidance and integrity rules in the provision of written advice to the company.

11.           The split of the purchase price of a share in an off-market buy-back between capital component and dividend component is determined by the Company through the way it accounts for the shares bought back. In particular, the capital component of the Purchase Price is the amount that is debited against amounts credited to the Company's share capital account.

12.           However, the Commissioner will have regard to the various anti-avoidance and integrity rules in the provision of written advice to the Company in relation to the capital/dividend split of the purchase price in relation to the off-market share buy-back.

13.           This is because a 'split' of the purchase price where the capital component is too low will both stream dividends and artificially increase capital losses to the vendor shareholders. Conversely, a purchase price where the capital component that is too high will provide or stream capital benefits at the expense of dividends to the vendor shareholder. Neither of these outcomes is desirable.[1]

14.           Paragraphs 61 and 62 of the PS LA 2007/9 states:

61. The ATO considers that there are a number of acceptable methodologies for ascertaining the capital/dividend split, although not all have equal applicability in every case. The following discussion is designed to provide guidance to tax officers in deciding whether to accept the dividend/capital split proposed or to apply one of the various anti-avoidance provisions of the ITAA 1936. All of these methodologies have been accepted by the ATO in cases involving share buy-backs. The question becomes which one is the most appropriate methodology in each case.

62. 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. This method does overcome the dilution issue discussed at paragraph 63 of this practice statement. Another clear advantage is that ACPS gives rise to a strong presumption that sections 45A and 45B of the ITAA 1936 would not apply to the buy-back. Tax officers should examine recent financial year data as well as projected movements in the average. Evidence of recent capital injections just before a share buy-back may attract the anti-avoidance provisions. ACPS should, prima facie, be applied to determine the capital component in an off-market share buy-back. The other methods discussed below may have particular relevance or application in specific instances only.

15.           In the absence of exceptional circumstances, the ACPS method will be applied to determine the capital component.[2]

16.           While the ACPS method is the ATO's preferred methodology for ascertaining the capital/dividend split of the purchase price in an off-market share buy-back, there are other acceptable methods that can be used.

17.           Gven the share buy-back has occurred and the Company has accounted for the transaction, what has to be determined is whether the methodology proposed to be employed is acceptable, and if not, whether the use of another methodology to determine the capital/dividend split of the purchase price is preferrable.

18.           The relevant question given the Company has determined the capital/dividend split of the purchase price for the purposes of the share buy-back is whether any of the various anti-avoidance rules and integrity measures should apply.

19.           The shares bought back were employee shares issued under an employee share scheme. It should be noted that Division 83A of the Income Tax Assessment Act 1997 and/or its potential interaction with the Division 16K is not a relevant consideration, as the shares bought back were not issued at a discount to market value because they were issued for a price determined by the valuation formula in Schedule 7 of the Agreement which is said to be equivalent to the market value of the share.

20.          Paragraph 62 of PS LA 2007/9 also advises that tax officers should:

•                     examine recent financial data as well as projected movements in the average capital per share.

•                     consider if there is any evidence of any recent capital injections just before the share buy-back.

21.          An analysis of the movements in the balance of the Company's share capital account the average capital per share for each share is significantly lower than the purchase price when the shareholder participating in the share buy-back acquired their shares. And there are no capital injections that occurred just before the share buy-back took place.

22.          In addition, the shareholder received dividends during their time holding the shares that represented its share of the profits that were available for distribution to the shareholder.

23.          The main concern with the Company treating the entirety of the purchase price of the share buy-back as being capital is whether the Company is providing a capital benefit under the share buy-back for a main or substantial tax purpose that should have been a dividend to the shareholder participating in the share buy-back.

24.          Paragraph 100 of PS LA 2007/9 states:

Speaking practically, to apply section 45B of the ITAA 1936 to a share buy-back requires objective evidence of a substantial tax purpose of substituting share capital for a part of the purchase price which would otherwise be a dividend. Details of the purpose test on which section 45B turns are explained below.

25.          In determining whether the requisite purpose is present in relation to share buy-back involving this shareholder, it is to be inferred objectively from the circumstances of the arrangement. This is facilitated by the non-exhaustive list of relevant circumstances listed in subsection 45B(8).

26.          There is no evidence to indicate that treating the share buy-back purchase price entirely on capital arose for mainly income tax reasons or to in provide a tax benefit to one of the shareholders of the Company. However, treating the purchase price entirely as capital, dilutes the Company's 'Share capital account'. If the Company was to adopt this approach in subsequent share buy-backs could contribute to a significant dilution of the Company's 'Share capital account', which may result in a possible breach of section 45B and for this reason it is not seen as acceptable capital/dividend split of the share buy-back purchase price.

27.          However, the Company using a share buy-back purchase price that is mostly capital is reasonable in this instance because:

(a)          the entirety of the amount the Company received for issuing the shares to the shareholder was credited to the Company's 'Share capital account'

(b)          this approach does not result in a share capital dilution effect that arises when treating the entirety of the share buy-back purchase price as capital

(c)           if the ACPS method was used to determine the capital/dividend split of the share buy-back purchase price then the resulting capital/dividend split would inappropriately skew the share buy-back purchase price from capital to a dividend

(d)          no franking credits will be streamed to the shareholder that was not a shareholder when the profits were made, and

(e)          no potential for capital benefits available to be distributed to other shareholders if any of the amount of the capital contributed to the Company's 'Share capital account' when the Class C shares were issued to the employee remained in the Company's 'Share capital account' after the share buy-back.

28.          The share buy-back arose because the employee left the employment with the Company There are no capital injections that have been made or any other arrangements just prior to this share buy-back that warrant the application of any anti-avoidance provisions in relation to the capital/dividend split of the purchase price for this particular share buy-back determined from how the Company has accounted for the share buy-back transaction.

29.          Accordingly, the share buy-back purchase price will be treated as capital to the amount the Company received upon issuing the shares to the shareholder that was credited to the Company's 'Share capital account' and the amount of the share buy-back purchase price that exceeds the capital amount will be treated as a dividend in accordance with subsection 150GZZZP(1).

[1] Paragraph 60 of PS LA 2007/9.

[2] Paragraph 12 of PS LA 2007/9.