Edited version of private advice

Authorisation Number: 1052319383367

Date of advice: 08 November 2024

Ruling

Subject: Imputation benefits

Question 1

Will the Commissioner make a determination under paragraph 177EA(5)(b) of the Income Tax Assessment Act 1936 (ITAA 1936) to deny the whole, or any part, of the imputation benefits received in relation to the dividend associated with the Buy-Back Price paid by Company A to the Sale Shareholders?

Answer 1

No.

Question 2

Will the Commissioner make a determination under paragraph 204-30(3)(c) of the Income Tax Assessment Act 1997 (ITAA 1997) to deny the whole, or any part, of the imputation benefits received in relation to the dividend associated with the Buy-Back Price paid by Company A to the Sale Shareholders?

Answer 2

No.

This ruling applies for the following periods:

Year ending 30 June 20XX

The scheme commenced on:

X/X/20XX

Relevant facts and circumstances

This private ruling is based on the facts and circumstances set out below. If your facts and circumstances are different from those set out below, this private ruling has no effect and you cannot rely on it. The fact sheet has more information about relying on your private ruling.

1.            A document entitled 'Share Buy-Back Agreement' has been entered into by four parties (Agreement). Those parties are:

(a)                Company A

(b)                Shareholder 1

(c)                Shareholder 2, and

(d)                Shareholder 3.

2.            Company A was incorporated on XX June 19XX and is an Australian resident. Each of Shareholder 1, Shareholder 2 and Shareholder 3 are shareholders of Company A, holding the following shares:

(a)                Shareholder 1, a company holds X ordinary shares in Company A

(b)                Shareholder 2, a company holds X ordinary shares in Company A, and

(c)                Shareholder 3, being two individuals jointly holds X ordinary shares in Company A,

(collectively the Shareholders).

3.            Each of the Shareholders is an Australian resident and have held their respective shares in the Company A since incorporation in 19XX.

4.            Company A has only one class of ordinary share on issue.

5.            The share capital of Company A has been since incorporation, and continues to be, $XXX (being $X per ordinary share).

6.            Company A is a manufacturer of products for supply to the Australian industrial market.

7.            As at X June 20XX, Company A has retained earnings of $XXX.

8.            Shareholder 2 and Shareholder 3 (Sale Shareholders) are desirous of exiting their respective investment in Company A as they are no longer wanting to be involved in the business carried on by Company A. The controllers of Shareholder 2 and the Shareholder 3 are of an age where it is a sensible time for them to exit the business.

9.            Given the cash reserve and retained earnings position of Company A, Company A intends to undertake a selective buy-back (Buy-Back). of the shares owned by the Sale Shareholders (Sale Shares) from the Sale Shareholders pursuant to the Share Buy-Back Agreement dated XX/X/20XX (the Agreement).

10.          The purpose of the Buy-Back mentioned in the Agreement is to provide an opportunity for the Sale Shareholders to exit their investment in Company A. The Sale Shareholders have expressed their desire to no longer be involved in the business and wish to sell their shares.

11.          Company A proposes to undertake the Buy-Back of the Sale Shares from the Sale Shareholders. The Buy- Back allows Company A to repurchase the shares at the Buy Back Price specified in the Agreement, which is $XXX for one ordinary share.

12.          By undertaking the Buy-Back, Company A aims to provide an exit strategy for the Sale Shareholders and allow them to realize the value of their investment in Company A. This transaction is to be conducted in accordance with the provisions of the Corporations Act 2001 (Corporations Act) and requires the approval of the Shareholders of Company A through a special or unanimous resolution.

13.          Overall, the purpose of the Buy-Back is to facilitate the voluntary sale of shares by the Sale Shareholders and provide them with a fair and agreed-upon price for their shares, allowing them to exit their investment in Company A, in circumstances where Company A has the capacity to undertake the Buy- Back.

14.          The Buy-Back Price comprises a dividend component and capital component. The Average Cost Per Share method is used to determine the respective dividend and capital component of the Buy-Back Price.

15.          The capital component will be debited to share capital in the amount of $XXX per ordinary share and the dividend component will be debited to retained earnings in the amount of $XXX per ordinary share.

16.          Dividends have been paid by Company A in the past. Where dividends have been paid by Company A in the past, they have been paid as fully franked dividends to all Shareholders.

17.          Company A will frank the dividends proportionately based on the total retained profits and franking credits available for XX% of the shareholders.

Relevant legislative provisions

Income Tax Assessment Act 1936 section 177EA

Income Tax Assessment Act 1936 subsection 177EA(3)

Income Tax Assessment Act 1936 paragraph 177EA(3)(b)

Income Tax Assessment Act 1936 paragraph 177EA(3)(c)

Income Tax Assessment Act 1936 paragraph 177EA(3)(d)

Income Tax Assessment Act 1936 paragraph 177EA(3)(e)

Income Tax Assessment Act 1936 paragraph 177EA(5)(b)

Income Tax Assessment Act 1936 subsection 177EA(14)

Income Tax Assessment Act 1936 paragraph 177EA(14)(b)

Income Tax Assessment Act 1936 subsection 177EA(17)

Income Tax Assessment Act 1936 paragraph 177EA(17)(a)

Income Tax Assessment Act 1936 paragraph 177EA(17)(b)

Income Tax Assessment Act 1936 paragraph 177EA(17)(c)

Income Tax Assessment Act 1936 paragraph 177EA(17)(d)

Income Tax Assessment Act 1936 paragraph 177EA(17)(f)

Income Tax Assessment Act 1936 paragraph 177EA(17)(g)

Income Tax Assessment Act 1936 paragraph 177EA(17)(ga)

Income Tax Assessment Act 1936 paragraph 177EA(17)(i)

Income Tax Assessment Act 1936 paragraph 177EA(17)(j)

Income Tax Assessment Act 1936 paragraph 177EA(19)(a)

Income Tax Assessment Act 1997 section 204-30

Income Tax Assessment Act 1997 subsection 204-30(1)

Income Tax Assessment Act 1997 paragraph 204-30(1)(a)

Income Tax Assessment Act 1997 paragraph 204-30(1)(b)

Income Tax Assessment Act 1997 paragraph 204-30(1)(c)

Income Tax Assessment Act 1997 paragraph 204-30(3)(c)

Income Tax Assessment Act 1997 paragraph 204-30(6)(a)

Income Tax Assessment Act 1997 subsection 204-30(8)

Income Tax Assessment Act 1997 paragraph 204-30(8)(b)

Income Tax Assessment Act 1997 Division 207

Does IVA apply to this private ruling?

Part IVA of the Income Tax Assessment Act 1936 contains anti-avoidance rules that can apply in certain circumstances where you or another taxpayer obtains a tax benefit, imputation benefit or diverted profits tax benefit in connection with an arrangement.

If Part IVA applies, the tax benefit or imputation benefit can be cancelled (for example, by disallowing a deduction that was otherwise allowable) or you or another taxpayer could be liable to the diverted profits tax.

We have not fully considered the application of Part IVA to the arrangement you asked us to rule on, or to an associated or wider arrangement of which that arrangement is part.

If you want us to rule on whether Part IVA applies, we will need to obtain and consider all the facts about the arrangement which are relevant to determining whether Part IVA may apply.

For more information on Part IVA, go to our website ato.gov.au and enter 'part iva general' in the search box on the top right of the page, then select 'Part IVA: the general anti-avoidance rule for income tax'.

Reasons for decision

Issue 1 - imputation benefits

Question 1

Will the Commissioner make a determination under paragraph 177EA(5)(b) of ITAA 1936 to deny the whole, or any part, of the imputation benefits received in relation to the dividend associated with the Buy-Back Price paid by Company A to the Sale Shareholders?

Summary

A determination will not be made under paragraphs 177EA(5)(b) of the ITAA 1936 to deny the Sale Shareholders imputation benefits in respect of the Buy-Back.

Detailed Reasoning

1.            Section 177EA of the ITAA 1936 is a general anti-avoidance provision that applies to a wide range of schemes designed to obtain imputation benefits. In essence, 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 may include an off-market share buy-back with a franked dividend component.

2.            Per paragraphs 20 and 21 of Taxation Ruling TR 2009/3 Income tax: application of section 177EA of the Income Tax Assessment Act 1936 to non-share distributions on certain 'dollar value' convertible notes:

20. Imputation benefits represent the tax paid by a company on its profits for the benefit of all its owners. Two of the basic principles of the imputation system are that imputation benefits are only to be available to the true economic owners of the company to the extent that those owners are personally able to use those franking credits, and that those true economic owners of the company are to have the tax paid at the company level imputed to them in proportion to their ownership of the company. A consequence of these principles is that an element of 'wastage' of franking credits is an intended feature of the tax system. 'Wastage' for this purpose includes prolonged deferment of use of franking credits (including cases where distribution of profits to economic owners is deferred because profits are reinvested). Deliberate strategies to prevent wastage by diverting imputation benefits from the true economic owners of a company undermine the principles of the imputation system.

21. Measures to counter practices that would undermine the principles of the imputation system were announced by the Treasurer on 13 May 1997. Broadly, the most obvious abuses involved a party - an owner of the company or the company itself - that could not directly realise the fullest economic advantages of imputation benefits, entering into an arrangement in relation to the benefits with another party that could better enjoy those benefits. There would typically be advantages to both parties under this arrangement. The second party would not have a true interest in the economic ownership of the company, or if it did, would receive imputation benefits by virtue of the arrangement that were disproportionate to its real ownership interests. [emphasis added]

3.            Subsection 177EA(3) of the ITAA 1936 provides that section 177EA applies if:

(a) there is a scheme for a disposition of membership interests, or an interest in membership interests, in a corporate tax entity;

(b) either:

(i) a frankable distribution has been paid, or is payable or expected to be payable, to a person in respect of the membership interests;

(ii) a frankable distribution has flowed indirectly, or flows indirectly or is expected to flow indirectly, to a person in respect of membership interests, as the case may be; and

(c) the distribution was, or is expected to be, a franked distribution or a distribution franked with an exempting credit; and

(d) except for this section, a person (the 'relevant taxpayer') would receive, or could reasonably be expected to receive, imputation benefits as a result of the distribution; and

(e) having regard to the relevant circumstances of the scheme, it would be concluded that the person, or one of the persons, who entered into or carried out the scheme or any part of the scheme did so for a purpose (whether or not the dominant purpose, but not including an incidental purpose) of enabling the relevant taxpayer to obtain an imputation benefit.

4.            Where section 177EA of the ITAA 1936 applies, the Commissioner has the discretion to make a determination to deny the imputation benefit to each participating shareholder pursuant to paragraph 177EA(5)(b) of the ITAA 1936.

5.            Subsection 177EA(14) of the ITAA 1936 provides the meaning of 'scheme for a disposition'. Paragraph 177EA(14)(b) of the ITAA 1936 states that a scheme for a disposition of membership interests includes a scheme that involves entering into any contract, arrangement, transaction of dealing that changes or otherwise affects the legal or equitable ownership of the membership interests or interest in membership interests.

Application to your circumstances

6.            The Sale Shareholders advised that a Buy-Back was contemplated as a result of them desiring to no longer be involved in the business conducted by Company A

7.            The Buy-Back constitutes a scheme for a disposition of membership interests, as a contract, arrangement or transaction that is proposed to be entered into, which would change the legal or equitable ownership of the membership interest. The conditions of paragraphs 177EA(3)(b) to (d) of the ITAA 1936 are also satisfied in respect of the Buy-Back.

8.            Accordingly, the issue is whether (see paragraph 177EA(3)(e) of the ITAA 1936), having regard to the relevant circumstances of the scheme, it would be concluded that on the part of Company A, its Shareholders or any other relevant party, there was more than a merely incidental purpose of conferring an imputation benefit under the scheme. In respect of the Buy-Back, the relevant taxpayers are Company A and the Sale Shareholders and the scheme comprises the circumstances surrounding the Buy-Back.

9.            In arriving at a conclusion the Commissioner must have regard to the relevant circumstances of the scheme which include, but are not limited to, the circumstances set out in subsection 177EA(17) of the ITAA 1936. The relevant circumstances listed in subsection 177EA(17) encompass a range of circumstances which, taken individually or collectively, could indicate the requisite purpose.

10.         The relevant circumstances as they apply in this case are:

(a)          the Sale Shareholders held the risks of loss and the opportunities for profit or gain the entire time they held shares in Company A, commencing from the incorporation date of Company A on XX June 19XX. The Sale Shareholders have not done anything to mitigate or alter the risks the Sale Shareholders were exposed to during the period they held shares in Company A (paragraph 177EA(17)(a) of the ITAA 1936)

(b)          all Shareholders are residents of Australia and would benefit from the franking credit offset, with the Sale Shareholders only deriving a greater benefit from the franking credits attached to the Buy-Back Price than the other Shareholder who is not participating in the proposed share buy-back in the income year in which the distribution was made, solely on the basis that the other Shareholder is not participating in the Buy-Back and not because of any of those matters set out in paragraph 177EA(19)(a) (paragraph 177EA(17)(b) of the ITAA 1936)

(c)           the franking credits are to be distributed in proportion to the Sale Shareholder's interest in Company A. As a result the issue of whether Company A could have retained or used franking credits to pay a franked distribution to another entity does not arise. (paragraphs 177EA(17)(c) and (d) of the ITAA 1936)

(d)          the Buy-Back Price does not include any consideration payable to the Sale Shareholder that represents the value of imputation credits (paragraph 177EA(17)(f) of the ITAA 1936)

(e)          neither is a deduction allowable nor a capital loss is incurred, in connection with the Buy-Back Price under the scheme, given the share capital component of the Buy-Back Price is nominal (paragraph 177EA(17)(g) of the ITAA 1936)

(f)            the Buy-Pack Price is not sourced from unrealised or untaxed profits (paragraph 177EA(17)(ga) of the ITAA 1936)

(g)          the Sale Shareholders held shares in Company A for an extended period of time, namely for approximately X years (paragraph 177EA(17)(i) of the ITAA 1936)

(h)          none of the matters referred to in subsection 177D(2) of the ITAA 1936 point towards a dominant tax purpose, given that there has not been any steps undertaken as part of the Buy-Back by any person which are contrived or artificial, there is also no disparity between the substance of the scheme and its form and there are no obvious timing advantages under the scheme (paragraph 177EA(17)(j) of the ITAA 1936), and

(i)            the only entities whose financial position has changed under the Buy-Back is Company A who has less share capital (which is immaterial given the nominal share capital position) and the Sale Shareholders whose financial position have changed due to the desire to exit Company A. Although the cash reserves of Company A will be reduced, Company A has the financial capacity to undertake the Buy-Back (paragraph 177EA(17)(j) of the ITAA 1936).

11.         The Buy-Back is being carried out to allow the Sale Shareholders to exit their investment, in circumstances where Company A has the financial capacity to undertake the Buy-Back. Based on a consideration of all of the relevant circumstances of the scheme, the Buy-Back is not for the main purpose to enable the Sale Shareholders to obtain imputation benefits, and any obtaining of imputation benefits is incidental. Neither Company A nor the Sale Shareholders entered into the scheme for a more than incidental purpose of enabling the Sale Shareholders to obtain an imputation benefit, and the imputation benefit is proportional to their underlying ownership interests in Company A.

12.         The Buy-Back is being carried out to allow the Sale Shareholders to exit their investment, in circumstances where Company A has the financial capacity to undertake the Buy-Back. Based on a consideration of all of the relevant circumstances of the scheme, the Buy-Back is not for the main purpose to enable the Sale Shareholders to obtain imputation benefits, and any obtaining of imputation benefits is incidental. In relation to the receipt of the Buy-Back price the Sale Shareholders will not receive more than X% of Company A's franking credits at the time of the share buy-back.

13.         Therefore, neither Company A nor the Sale Shareholders entered into the scheme for a more than incidental purpose of enabling the Sale Shareholders to obtain an imputation benefit, and the imputation benefit is proportional to their underlying ownership interests in Company A.

Conclusion

14.         As the 5 conditions in subsection 177EA(3) of the ITAA1936 are not satisfied in relation to the Buy-Back, section 177EA of the ITAA 1936 does not apply to the circumstances around the Buy-Back to be conducted by Company A on the shares held by the Sale Shareholder in Company A

15.         As section 177EA of the ITAA 1936 does not apply to scheme, the Commissioner will not have discretion to deny the imputation benefit to each Sale Shareholder pursuant to paragraph 177EA(5)(b) of the ITAA 1936.

Issue 2 - streaming distributions

Question 2

Will the Commissioner make a determination under paragraph 204-30(3)(c) of the Income Tax Assessment Act 1997 (ITAA 1997) to deny the whole, or any part, of the imputation benefits received in relation to the dividend associated with the Buy-Back Price paid by Company A to the Sale Shareholders?

Summary

In relation to the Buy-Back, the distributions are not streamed and a determination will not be made under paragraph 204-30(3)(c) of the ITAA 1997 to deny the Sale Shareholders imputation benefits in respect of the Buy-Back of the Sale Shares.

Detailed reasoning

16.         Subsection 204-30(1) of the ITAA 1997 empowers the Commissioner to make certain determinations if a corporate tax entity streams one or more distributions, or one or more distributions and the giving of other benefits, to its members in such a way that:

(a) an 'imputation benefit' is, or apart from section 204-30 of the ITAA 1997 would be, received by a member of the entity as a result of the distribution or distributions (paragraph 204-30(1)(a) of the ITAA 1997)

(b) the member would derive a 'greater benefit from franking credits' than another member of the entity (paragraph 204-30(1)(b) of the ITAA 1997), and

(c) the other member of the entity will receive lesser imputation benefits, or will not receive any imputation benefits, whether or not the other member receives other benefits (paragraph 204-30(1)(c) of the ITAA 1997).

17.         An imputation benefit is (relevantly) received as a result of a distribution where a member is entitled to a tax offset under Division 207 of the ITAA 1997 (paragraph 204-30(6)(a) of the ITAA 1997).

18.         For section 204-30 of the ITAA 1997 to apply, a member of an entity must derive a greater benefit from franking credits. The member that derives the greater benefit from franking credits is the favoured member. The member that receives the lesser imputation benefits is the disadvantaged member. Some of the cases in which a member of an entity 'derives a greater benefit from franking credits' are listed in subsection 204-30(8) of the ITAA 1997 by reference to the ability of a member to fully utilise franking credits.

19.         For instance, under subsection 204-30(8)(b) of the ITAA 1997 a member of an entity 'derives a greater benefit from franking credits' attached to a distribution if the other member would not be entitled to a tax offset under Division 207 of the ITAA 1997.

20.         The term 'streaming' is not defined in the ITAA 1997. Streaming of distributions is broadly explained in paragraph 3.28 of the Explanatory Memorandum to the New Business Tax System (Imputation) Bill 2022 as selectively directing the flow of franked distributions to those members who can most benefit from imputation benefits.

21.         Under the Buy-Back, the Sale Shareholders will be provided with an imputation benefit as a result of franking the dividend component to be paid in relation to the buy-back of their shares. The imputation benefit to be provided under the Buy-Back does not constitute streaming of a distribution to a favoured member. The imputation benefit provided to the Sale Shareholders will be merely incidental to their exit from Company A, and in relative terms the franking credits attached to the distribution will be proportionate to the Sale Shareholder's share of Company A's franking credit balance.

22.         Company A will pay franking credits to the Sale Shareholders based on their shares held and none of the shareholders of Company A are held by non-resident shareholders who do not benefit from franking credits to the same extent as the Sale Shareholders. Therefore, the conditions in subsection 204-30(1) of the ITAA 1997 will not be met.

Conclusion

23.         The Commissioner is of the view section 204-30 of the ITAA 1997 does not apply and therefore will not make a determination in relation to the imputation benefits that the Sale Shareholders will receive arising out of the Buy-Back.