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Edited version of private advice
Authorisation Number: 1052373416950
Date of advice: 19 March 2025
Ruling
Subject: Proposed share buy-back
Question 1
Will the proposed Share Buy-Back by the Company constitute a buy-back which is an 'off-market purchase' for the purposes of Division 16K of the Income Tax Assessment Act 1936 (ITAA 1936) pursuant to section 159GZZZK of the ITAA 1936?
Answer 1
Yes.
Question 2
Will the difference between the Share Buy-Back Price and the portion of the Share Buy-Back Price debited to the Company's share capital account be taken to be a dividend paid out of the company's profits under subsection 159ZZZP(1) of the ITAA 1936?
Answer 2
Yes.
Question 3
Will the Commissioner accept that the Share Buy-Back Price is not subject to adjustment under section 159GZZZQ of the ITAA 1936?
Answer 3
Yes.
Question 4
Will the Share Buy-Back result in a dividend assessable to the shareholders under subsection 44(1) of the ITAA 1936?
Answer 4
Yes.
Question 5
Will the Dividend Component under the Share Buy-Back be a frankable distribution and therefore capable of being franked pursuant to section 202-40 of the Income Tax Assessment Act 1997 (ITAA 1997)?
Answer 5
Yes.
Question 6
Will the Commissioner conclude that none of the provisions of section 207-145 of ITAA 1997 will apply to the Share Buy-back?
Answer 6
Yes.
Question 7
Will the Commissioner accept that none of the provisions of sections 45A, 45B and 45C of the ITAA 1936 will apply to the Share Buy-Back?
Answer 7
Yes.
This private ruling applies for the following period:
Income year ended 30 June 20XX
The scheme commenced on:
1 July 20YY
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.
The Company is undertaking a Share Buy-Buy prior to the sale of the business via a share sale (Share Sale) to an unrelated third party (Purchaser) at arm's length.
The Share Buy-Back Price will include a Capital Component per share equal to the cost base of the shares that will debited to the Company's capital account. The remaining Share Buy-Back Price per share will be a fully franked Dividend Component in accordance with the Average Capital Per Share (ACPS) methodology outlined in Practice Statement Law AdministrationPS LA 2007/9 Share buy-backs.
The Share Buy-Back Price (per share) will be approximately the same as the price per share for the Share Sale.
The Company will have sufficient franking credits to fully frank the Dividend Component.
The commercial reasons for implementing the Share Buy-Back prior to the Share Sale have been provided.
The Company and the shareholders are all Australian residents for tax purposes.
The shareholders do not have any carried forward capital or income tax losses.
Assumptions
The methodology to determine the market value of the Company shares at the time of the Share Buy-Back will be in accordance with Australian Taxation Office 'Market valuation for tax purposes' guidelines.
Relevant legislative provisions
Income Tax Assessment Act 1936 Division 16K
Income Tax Assessment Act 1936 subsection 44(1)
Income Tax Assessment Act 1936 section 45A
Income Tax Assessment Act 1936 subsection 45A(3)
Income Tax Assessment Act 1936 subsection 45A(4)
Income Tax Assessment Act 1936 section 45B
Income Tax Assessment Act 1936 subsection 45B(2)
Income Tax Assessment Act 1936 subsection 45B(5)
Income Tax Assessment Act 1936 subsection 45B(8)
Income Tax Assessment Act 1936 subsection 45B(9)
Income Tax Assessment Act 1936 section 45C
Income Tax Assessment Act 1936 former section 46F
Income Tax Assessment Act 1936 section 159GZZZK
Income Tax Assessment Act 1936 section 159GZZZP
Income Tax Assessment Act 1936 subsection 159ZZZP(1)
Income Tax Assessment Act 1936 section 159GZZZQ
Income Tax Assessment Act 1936 subsection 159GZZZQ(1)
Income Tax Assessment Act 1936 subsection 159GZZZQ(2)
Income Tax Assessment Act 1936 former section 160APHD
Income Tax Assessment Act 1936 former subsection 160APHM(2)
Income Tax Assessment Act 1936 former section 160APHN
Income Tax Assessment Act 1936 former subsection 160APHN(3)
Income Tax Assessment Act 1936 former section 160APHO
Income Tax Assessment Act 1936 section 177A
Income Tax Assessment Act 1936 section 177E
Income Tax Assessment Act 1936 subsection 177E(1)
Income Tax Assessment Act 1936 section 177EA
Income Tax Assessment Act 1936 subsection 177EA(3)
Income Tax Assessment Act 1936 subsection 177EA(5)
Income Tax Assessment Act 1936 subsection 177EA(17)
Income Tax Assessment Act 1936 subsection 318(2)
Income Tax Assessment Act 1997 subsection 6(1)
Income Tax Assessment Act 1997 section 202-5
Income Tax Assessment Act 1997 section 202-40
Income Tax Assessment Act 1997 subsection 202-40(1)
Income Tax Assessment Act 1997 section 202-45
Income Tax Assessment Act 1997 section 204-30
Income Tax Assessment Act 1997 subsection 204-30(1)
Income Tax Assessment Act 1997 subsection 204-30(3)
Income Tax Assessment Act 1997 subsection 204-30(6)
Income Tax Assessment Act 1997 subsection 204-30(8)
Income Tax Assessment Act 1997 Division 207
Income Tax Assessment Act 1997 section 207-35
Income Tax Assessment Act 1997 section 207-145
Income Tax Assessment Act 1997 subsection 207-145(1)
Income Tax Assessment Act 1997 section 207-155
Income Tax Assessment Act 1997 section 207-157
Income Tax Assessment Act 1997 subsection 207-157(1)
Income Tax Assessment Act 1997 subsection 207-157(3)
Income Tax Assessment Act 1997 section 207-158
Income Tax Assessment Act 1997 subsection 207-158(1)
Income Tax Assessment Act 1997 subsection 207-158(2)
Income Tax Assessment Act 1997 subsection 832-120(1)
Income Tax Assessment Act 1997 subsection 832-130(7)
Income Tax Assessment Act 1997 subsection 975-300(1)
Reasons for decision
Question 1
Summary
The Share Buy-Back constitutes an off-market share buy-back within the meaning of Division 16K of the ITAA 1936.
Detailed reasoning
Broadly, Division 16K of the ITAA 1936 outlines the income tax consequences of share buy-backs. This division applies where a company buys a share in itself from its shareholders and as a result cancels the share.
Section 159GZZZK of the ITAA 1936 provides that share buy-backs take the form of an on-market purchase or an off-market purchase. In accordance with paragraph 159GZZZK(d) of the ITAA 1936, a share buy-back will be an off-market purchase where it is not an on-market purchase. Paragraph 159GZZZK(c) of the ITAA 1936 provides that an on-market purchase will arise 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 Company is not listed for quotation in the official list of a stock exchange in Australia or elsewhere and therefore it cannot be made in the ordinary course of trading on that stock exchange. Therefore, in accordance with paragraph 159GZZZK(d) of the ITAA 1936, the proposed Share Buy-Back will constitute an off-market purchase for the purpose of Division 16K of the ITAA 1936.
Question 2
Summary
The difference between the Share Buy-Back Price and the portion of the Share Buy-Back Price debited to the Company's share capital account will be taken to be a dividend paid out of the company's profits under subsection 159ZZZP(1) of the ITAA 1936.
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.
A company's 'share capital account' is defined in subsection 975-300(1) of the ITAA 1997 as an account that the company keeps of its share capital or any other account, whether or not called a share capital account, created on or after 1 July 1998, where the first amount credited to the account was an amount of share capital.
PS LA 2007/9provides the acceptable methodologies to calculate the dividend/capital split of a share buy-back. The ACPS method is the preferred method and requires a company's ordinary issued capital to be divided by the number of shares on issue to give a reasonable estimation of the capital component of a purchase price (with any amount in excess reflecting the dividend component). It also recognises that alternative methodologies are acceptable if exceptional circumstances exist to warrant the use of an alternative method.
The Company's contributed equity account represents a share capital account for income tax purposes on the basis that it is an account where the Company keeps its share capital. The Capital Component (calculated in accordance with the ACPS) will be debited to the Company's contributed equity account.
Accordingly, the Dividend Component, being the difference between the Share Buy-Back Price and the Capital Component will be taken to be a dividend in accordance with subsection 159GZZZP(1) of the ITAA 1936.
The Dividend Component will be taken to be a dividend paid by the Company to the shareholder's, out of profits derived by the Company on the day of the Share Buy-Back under subsection 159GZZZP(1) of the ITAA 1936.
Question 3
Summary
The Commissioner will accept that the Share Buy-Back Price is not subject to an adjustment under section 159GZZZQ of the ITAA 1936.
Detailed reasoning
Subsection 159GZZZQ(1) of the ITAA 1936 provides that a shareholder is taken to have received an amount equal to the purchase price as consideration in respect of the sale of the share bought back. However, this amount is subject to certain adjustments in order to arrive at the deemed consideration.
Subsection 159GZZZQ(2) of the ITAA 1936 is one of the adjusting provisions. It provides that if the purchase price is less than the market value of the share at the time of the buy-back (calculated as if the buy-back did not occur and was never proposed to occur), the shareholder is taken to have received an amount equal to the market value as consideration in respect of the sale of the share bought back.
In this case, the Share Buy-Back price will be approximately the same as the sale price per share of the shares that was negotiated with the Purchaser, an unrelated third party. Also, in accordance with the assumption in this private ruling, the methodology to determine the market value of the Company shares at the time of the Share Buy-Back will be in accordance with Australian Taxation Office 'Market valuation for tax purposes' guidelines.
Due to this, it is accepted that the Share Buy-Back Price of the Company Shares held by the shareholders is equal to the market value of those shares at the time of the Share Buy-Back.
Accordingly, subsection 159GZZZQ(2) of the ITAA 1936 will not apply as the Share Buy-Back Price is equal to market value of each buy-back share at the time of the Share Buy-Back, as if the buy-back did not occur and was never proposed to occur.
Question 4
Summary
The Share Buy-Back will result in a dividend that is assessable to the shareholders under subsection 44(1) of ITAA 1936.
Detailed reasoning
Subsection 44(1) of the ITAA 1936 includes in a shareholder's assessable income any dividends paid to the shareholder out of profits derived by the company from any source (if a resident of Australia) and from an Australian source (if a non-resident).
The term 'dividend' in subsection 6(1) of the ITAA 1936 includes any distribution made by a company to any of its shareholders. However, paragraph (d) of the definition of dividend in subsection 6(1) of the ITAA 1936 excludes a distribution from the meaning of dividend if the amount of a distribution is debited against an amount standing to the credit of the company's share capital account.
The Dividend Component will be taken to be a dividend paid by the Company to the shareholders, out of profits derived by the Company on the day of the Share Buy-Back under subsection 159GZZZP(1) of the ITAA 1936.
Accordingly, the Dividend Component will be included in the assessable income of the shareholders under subsection 44(1) of the ITAA 1936 in the year of income in which the Share Buy-Back occurs.
Question 5
Summary
The Dividend Component under the Share Buy-Back will be a frankable distribution and therefore will be capable of being franked pursuant to section 202-40 of ITAA 1997.
Detailed reasoning
Under subsection 202-40(1) of the ITAA 1997, a distribution is a frankable distribution to the extent it is not unfrankable under section 202-45.
Section 202-45 of the ITAA 1997 provides a number of instances in which distributions are unfrankable distributions. Paragraph 202-45(c) is relevant to off-market share buy-backs and provides that where a distribution that is taken to be a dividend under section 159GZZZP of the ITAA 1936, it is unfrankable to the extent that the share buy-back price exceeds the market value of the share at the time of the buy-back if the share buy-back did not occur and was never proposed to occur.
In accordance with the assumption in this private ruling, the methodology to determine the market value of the Company shares at the time of the Share Buy-Back is consistent with Australian Taxation Office 'Market valuation for tax purposes' guidelines. Further, the Share Buy-Back Price will be approximately the same as the price per share for the Share Sale which has been negotiated with an unrelated third party. Therefore, it is considered that the Share Buy-Back Price does not exceed the market value of each buy-back share at the time of the buy-back if the buy-back did not occur and was never proposed to occur.
Accordingly, paragraph 202-45(c) of the ITAA 1997 will not apply to treat any part of the Dividend Component as an unfrankable dividend. None of the other paragraphs of section 202-45 apply to treat some or all of the Dividend Component of the Share Buy-Back Price as an unfrankable distribution for the purposes of subsection 202-40(1).
As a result, the Dividend Component will be a frankable distribution under section 202-40 of the ITAA 1997 and therefore, capable of being franked in accordance with section 202-5 of the ITAA 1997.
Question 6
Summary
Section 207-145 of the ITAA 1997 will not apply to the Share Buy-Back to deny the shareholders a franking credit gross up and franking credit tax offset in Division 207, when they receive the fully franked Dividend Component of the Share Buy-Back.
Detailed reasoning
Subdivision 207-F of the ITAA 1997 contains integrity measures which can deny franking credits to recipients if the imputation system is manipulated.
If a franked distribution is made to an entity in one or more of the circumstances listed in subsection 207-145(1) of the ITAA 1997, the amount of the franking credit will not be included in the assessable income of that entity and it will not be entitled to a tax offset for the distribution.
Section 207-145 of the ITAA 1997 applies if a franked distribution is made to an entity in one or more of the following circumstances outlined in paragraphs 207-145(a) to (db):
(a) the entity is not a qualified person in relation to the distribution
(b) the Commissioner has made a determination under paragraph 177EA(5)(b) of the ITAA 1936 that no imputation benefit is to arise in respect of the distribution for the entity
(c) the Commissioner has made a determination under paragraph 204-30(3)(c) of the ITAA 1997 that no imputation benefit is to arise in respect of the distribution for the entity
(d) the distribution is made as part of a dividend stripping operation
(da) the distribution is one to which section 207-157 (which is about distribution washing) applies, and
(db) the distribution is one to which section 207-158 (which is about foreign income tax deductions) applies.
Paragraph 207-145(1)(a) of the ITAA 1997 - qualified person
An entity must be a qualified person in relation to a dividend in order to be entitled to a tax offset in respect of the franking credit on a dividend (subsection 207-145(1) of the ITAA 1936). The qualified person test ensures only the true economic owners of shares benefit from franking credits attached to distributions made from the shares.
Paragraph 207-145(1)(a) of the ITAA 1997, which refers to Division 1A of former Part IIIAA of the ITAA 1936, provides the statutory tests that must be satisfied to be a qualified person in respect of a franked distribution received in order to be entitled to a tax offset for the franking credit on the distribution.
A shareholder is generally a qualified person, as defined by former section 160APHO of the ITAA 1936, if they satisfy the:
• holding period rule, and
• where applicable, the related payments rule.
If the shares are not preference shares, the holding period rule will be satisfied where the shareholder has held their shares 'at risk' for a continuous period of at least 45 days during the primary qualification period. In accordance with subsection 160APHM(2) of the ITAA 1936, shares are not held at risk where the shareholder has materially diminished risks of loss or opportunities for gain in respect of the shares. The primary qualification period is defined in former section 160APHD as beginning on the day after the shares were acquired and ending 45 days after the shares become ex-dividend.
A share, in respect of which a dividend is paid, becomes ex dividend on the day after the last day on which the acquisition by a person of the share will entitle that person to receive the dividend.
If the shareholder or associate is under an obligation to make, or is likely to make a 'related payment' in respect of the distribution, and the shares are not preference shares, the shares must also be held at risk for a continuous period of at least 45 days during the secondary qualification period (this is known as the 'related payments rule'). The secondary qualification period as defined by former section 160APHD of the ITAA 1936 begins 45 days before the ex-dividend date and ends 45 days after.
Examples of what constitutes the making of a related payment for the purposes of Division 1A of former Part IIIAA of the ITAA 1936 are provided in former section 160APHN of the ITAA 1936. Broadly, a related payment is where a shareholder has done, or is obliged to do, anything having the effect of passing the benefit of the interim dividend to one or more other persons.
Former subsection 160APHN(3) of the ITAA 1936 lists examples of what may have the effect of passing the benefit of a dividend to one or more other persons, for example, causing an amount or amounts to be set off against, or to be otherwise applied in reduction of, a debt or debts owed by the other person or other persons (former paragraph 160APHN(3)(f) of the ITAA 1936).
Paragraph 4.93 of the Explanatory Memorandum to Taxation Laws Amendment Bill (No. 4) 1998 further expands on the above, stating 'if the benefit of the dividend or distribution remains with the taxpayer, there will not be a related payment'.
Both the primary and secondary qualification periods do not include the day of acquisition or, if the shares have been disposed of, the day of disposal. Also excluded are days where the financial risk of owning the shares is materially diminished.
Application to your circumstances
Although the Dividend Component may be considered to have been taken into account in determining the sale price of the Share Sale, the shareholders will not make a related payment in relation to the Dividend Component.
As the shareholders will not have an obligation to make a related payment in respect of the Dividend Component, the shareholders will be required to satisfy the primary qualification period in respect of the Dividend Component.
The shareholders have held their shares in the Company since it was established. It has been stated that no position will be taken by any of the shareholders or associates at any time prior to the Share Buy-Back that will reduce the risk of holding the Company shares. Therefore, the shareholders will have continuously held the shares at risk for more than 45 days before the shares become ex-dividend.
Accordingly, the primary qualification period will be satisfied and the shareholders will be qualified persons in respect of the Dividend Component.
Consequently, paragraph 207-145(1)(a) of the ITAA 1997 will not apply to deny the shareholders a franking credit gross up and franking credit tax offset in Division 207 when they receive the fully franked Dividend Component of the Share Buy-Back.
Paragraph 207-145(1)(b) of the ITAA 1997 - determination under paragraph 177EA(5)(b) of the ITAA 1936
Section 177EA of the 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 includes a share buy-back with a franked dividend component.
Where section 177EA of the ITAA 1936 applies, the Commissioner may make a determination that a debit arises in the franking account of the corporate tax entity which made the distribution pursuant to paragraph 177EA(5)(a) where the entity is a party to the scheme. Alternatively, the Commissioner may make a determination that no imputation benefit arises for the relevant (recipient) taxpayer pursuant to paragraph 177EA(5)(b).
Subsection 177EA(3) of the ITAA 1936 provides that section 177EA of the ITAA 1936 applies if:
(a) there is a scheme for a disposition of membership interests, or an interest in membership interests, in a corporate tax entity; and
(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; or
(ii) a frankable distribution has flowed indirectly, or flows indirectly or is expected to flow indirectly, to a person in respect of the interest in 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, the 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.
Based on the facts, it is considered that the conditions of paragraphs 177EA(3)(a) to 177EA(3)(d) of the ITAA 1936 are satisfied because:
• The Company is a corporate tax entity. As the off-market share buy-back of the company's shares constitutes a scheme for a disposition of membership interests, paragraph 177EA(3)(a) of the ITAA 1936 is satisfied
• as the Dividend Component the Shareholders are expected to receive under the Share Buy-Back is a frankable distribution, paragraph 177EA(3)(b) of the ITAA 1936 is satisfied
• as the Dividend Component is expected to be a fully franked distribution, paragraph 177EA(3)(c) of the ITAA 1936 is satisfied, and
• as the shareholders will receive imputation benefits as a result of receiving the Dividend Component, paragraph 177EA(3)(d) of the ITAA 1936 is satisfied.
The question is therefore whether, having regard to the relevant circumstances of the scheme, it would be concluded that, on the part of the Company, its shareholders or any other relevant party, there is a more than an incidental purpose of conferring an imputation benefit under the scheme. Under this arrangement, the relevant taxpayers are the shareholders and the scheme comprises the circumstances surrounding the Share Buy-Back.
Subsection 177EA(17) of the ITAA 1936 outlines the relevant circumstances of a scheme that need to be considered in determining whether there was a more than incidental purpose of enabling a relevant taxpayer to obtain an imputation benefit.
The relevant circumstances listed in subsection 177EA(17) of the ITAA 1936 encompass a range of circumstances, which taken individually or collectively, could indicate the requisite purposes. Due to the diverse nature of the circumstances, some may or may not be present at any one time in relation to a particular scheme.
After consideration of the relevant circumstances, the Commissioner concludes that the provision of imputation benefits to the shareholders was incidental to the off-market Share Buy-Back.
The Commissioner therefore concludes that the Company and the shareholders did not enter into the Share Buy-Back for a more than incidental purpose of enabling the shareholders to obtain an imputation benefit.
The Commissioner will therefore not make a determination under paragraph 177EA(5)(b) of the ITAA 1936.
Consequently, paragraph 207-145(1)(b) of the ITAA 1997 will not apply to deny the shareholders a franking credit gross up and franking credit tax offset in Division 207 when they receive the fully franked Dividend Component of the Share Buy-Back.
Paragraph 207-145(1)(c) of the ITAA 1997 - determination under paragraph 204-30(3)(c)
Subsection 204-30(1) of the ITAA 1997 applies where a corporate tax entity streams the payment of dividends, or the payment of dividends and the giving of other benefits, to its members in such a way that:
(a) an imputation benefit is, or apart from this section would be, received by a member of the entity as a result of the distribution or distributions, and
(b) the member would derive a greater benefit from franking credits than another member of the entity, 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.
Relevantly, if section 204-30 of the ITAA 1997 applies, the Commissioner is vested with a discretion under subsection 204-30(3) to make a determination in writing either:
(a) that a specified franking debit arises in the franking account of the entity, for a specified distribution or other benefit to a disadvantaged member
(b) that a specified exempting debit arises in the exempting account of the entity, for a specified distribution or other benefit to a disadvantaged member, or
(c) that no imputation benefit is to arise in respect of a distribution that is made to a favoured member and specified in the determination.
An imputation benefit is defined in subsection 204-30(6) of the ITAA 1997 and includes, amongst other things, where a member is entitled to a tax offset under Division 207 of the ITAA 1997 or if an amount would be included in the member's assessable income pursuant to section 207-35 of the ITAA 1997.
The shareholders will receive an imputation benefit in accordance with subsection 204-30(6) of the ITAA 1997 when they receive the fully franked Dividend Component of the Share Buy-Back. Accordingly, paragraph 204-30(1)(a) is satisfied.
Paragraph 204-30(1)(b) of the ITAA 1997 requires that the shareholders must derive a greater benefit from imputation benefits received under the Share Buy-Back than the shareholders who will not participate in the Share Buy-Back. The words 'derive a greater benefit from franking credits' (imputation benefits) are defined in subsection 204-30(8) by reference to the ability of the members to fully utilise imputation benefits.
It is considered that the shareholders will not derive a greater benefit from receiving a franked distribution when they receive the Dividend Component. Accordingly, paragraph 204-30(1)(b) of the ITAA 1997 is not satisfied in relation to the Share Buy-Back.
Therefore, all the requirements of subsection 204-30(1) of the ITAA 1997 are not satisfied and it is concluded that the Company will not be taken to direct the flow of dividends in such a manner as to ensure that imputation benefits are derived by members who derive greater benefit from franking credits while other members receive lesser or no imputation benefits.
Accordingly, the Commissioner will not make a determination under subsection 204-30(3) of the ITAA 1997 that section 204-30 applies to the whole, or any part, of the dividend component of the Share Buy-Back Price.
Consequently, subsection 204-30(3) and paragraph 207-145(1)(c) of the ITAA 1997 will not apply to deny the shareholders a franking credit gross up and franking credit tax offset in Division 207 when they receive the fully franked Dividend Component of the Share Buy-Back.
Paragraph 204-145(1)(d) of the ITAA 1997 - dividend stripping operation
Broadly, sections 207-155 of the ITAA 1997 and 177E of the ITAA 1936 are directed at dividend stripping arrangements.
Section 207-155 of the ITAA 1997 provides that a distribution made to a member of a corporate tax entity is taken to be made as part of a dividend stripping operationif, and only if, the making of the distribution arose out of, or was made in the course of, a scheme that:
(a) was by way of, or in the nature of, dividend stripping; or
(b) had substantially the effect of a scheme by way of, or in the nature of, dividend stripping.
Similarly, section 177E of the ITAA 1936 is an extension to the general anti-avoidance provisions in Part IVA that applies to dividend stripping arrangements and applies where:
• any property of the company is disposed of as a result of:
- a scheme by way of or in the nature of dividend stripping; or
- a scheme having substantially the effect of a scheme by way of or in the nature of dividend stripping: paragraph 177E(1)(a)
• in the Commissioner's opinion, the disposal of that property represents a distribution of the company's profits (whether from the current, or an earlier or later accounting period): paragraph 177E(1)(b), and
• if the company paid a dividend out of profits immediately before the scheme, it would have been included, or might reasonably be expected to have been included, in the taxpayer's assessable income: paragraph 177E(1)(c).
If section 177E of the ITAA 1936 applies, then:
• the scheme shall be taken to be a scheme to which Part IVA applies: paragraph 177E(1)(e), and
• the taxpayer is taken to have obtained a tax benefit under Part IVA, equal to the amount which would (or might reasonably be expected to) have been included in the taxpayer's assessable income: paragraphs 177E(1)(f) and 177E(1)(g).
Dividend stripping is not a defined term, and it does not have a precise legal meaning. The meaning of dividend stripping is considered in paragraphs 8 to 10 of Taxation Ruling IT 2627 Income Tax: Application of Part IVA to Dividend Stripping Arrangements, which state:
8. The term 'dividend stripping' has no precise legal meaning. Therefore, it is not possible in this Ruling to provide exhaustive definitions of what does and what does not satisfy that expression.
9. However, it can be said that in its traditional sense a dividend stripping scheme would include one where a vehicle entity (the stripper) purchases shares in a target company that has accumulated or current years' profits that are represented by cash or other readily-realisable assets. The stripper pays the vendor shareholders a capital sum that reflects those profits and then draws off the profits by having paid to it a dividend (or a liquidation distribution) from the target company.
10. No exhaustive list of other examples can be given of what might constitute a dividend stripping scheme for the purposes of section 177E. Having regard to the overall scope and purpose of the section, an important element to be looked at will be any release of profits of a company to its shareholders in a non-taxable form, regardless of the different methods that might be used to achieve this result.
Dividend stripping is further considered in Taxation Determination TD 2014/1 Income tax: is the 'dividend access share' arrangement of the type described in this Taxation Determination a scheme 'by way of or in the nature of dividend stripping' within the meaning of section 177E of Part IVA of the Income Tax Assessment Act 1936?
Paragraph 17 of TD 2014/1 states that the common characteristics of a dividend stripping scheme include:
i. a target company with substantial undistributed profits creating a potential tax liability, either for the company or its shareholders;
ii. the sale or allotment of shares in the target company to another party;
iii. the payment of a dividend to the purchaser or allottee of the shares out of the target company's profits;
iv. the purchaser or allottee escaping Australian income tax on the dividend so declared;
v. the vendor shareholders receiving a capital sum for the shares in an amount the same as or very close to the dividends paid to the purchasers (there being no capital gains tax at the relevant times); and
vi. the scheme being carefully planned, with all the parties acting in concert, for the predominant if not the sole purpose of the vendor shareholders, in particular, avoiding tax on a distribution of dividends by the target company.
In respect of the Dividend Component under the Share Buy-Back, it cannot be concluded that this is part of a dividend stripping scheme as it does not have the characteristics of such a scheme as outlined in TD 2014/1.
Accordingly, the actions of the Company will not constitute a scheme that is by way of, or in the nature of dividend stripping, nor have substantially the same effect of such a scheme for the purposes of paragraph 177E(1)(a) of the ITAA 1936 and section 207-155 of the ITAA 1997.
Therefore, the Dividend Component of the Share Buy-Back is not taken to be made as part of a dividend stripping operation and paragraph 207-145(1)(d) of the ITAA 1997 will not apply to deny the shareholders a franking credit gross up and franking credit tax offset in Division 207 when they receive the fully franked Dividend Component of the Share Buy-Back.
Paragraph 207-145(1)(da) of the ITAA 1997 - distribution washing under section 207-157
The distribution washing rules in section 207-157 of the ITAA 1997 will apply to a franked distribution received by a member of a corporate tax entity on a membership interest (washed interest) where the following two requirements are met:
(a) the washed interest was acquired after the member, or a connected entity of the member, disposed of a substantially identical membership interest, and
(b) a corresponding franked distribution is made to the member, or the connected entity, on the substantially identical interest.
Without limiting paragraph 207-157(1)(a) of the ITAA 1997, subsection 207-157(3) provides that a membership interest is substantially identical to the washed interest if it is any one or more of the following:
(a) fungible with, or economically equivalent to, the washed interest;
(b) a membership interest in the same *corporate tax entity as the washed interest and of a class that is the same as, or not materially different from, the washed interest;
(c) a membership interest in the same corporate tax entity as the washed interest and of a class that is exchangeable at a fixed rate for an interest of the same class as the washed interest;
(d) a membership interest in another corporate tax entity that holds predominantly membership interests that are covered by any of the preceding paragraphs;
(e) a membership interest in another corporate tax entity that is exchangeable at a fixed rate for interests that are covered by any one or more of paragraphs (a) to (c).
In this situation, shareholders did not acquire the shares in the Company after they, or a connected entity disposed of a substantially identical membership interest. The shareholders acquired the shares in the Company when it was established. Once the shares are bought back by the Company, they will be cancelled and therefore will not be able to be reacquired by any entity.
As there is no disposal and subsequent acquisition of substantially identical membership interests, paragraph 207-157(1)(a) of the ITAA 1997 is not satisfied and therefore section 207-157 of the ITAA 1997 will not apply to the Dividend Component of the Share Buy-Back.
Consequently, section 207-157 and paragraph 207-145(1)(da) of the ITAA 1997 will not apply to deny the shareholders a franking credit gross up and franking credit tax offset in Division 207 when they receive the fully franked Dividend Component of the Share Buy-Back.
Paragraph 207-145(1)(db) of the ITAA 1997 - foreign income tax deductions under section 207-158
Subsection 207-158(1) of the ITAA 1997 provides that section 207-158 applies to a franked distribution if all or part of the distribution gives rise to a foreign income tax deduction. Subsection 207-158(2) of the ITAA 1997 provides for some exceptions that are not applicable in this situation.
Subsection 832-120(1) of the ITAA 1997 provides that an amount of a loss or outgoing is a foreign income tax deduction in a foreign country in a foreign tax period to which an entity is entitled, if the entity is entitled to deduct the amount in working out its tax base for the foreign tax period under a law of the foreign country dealing with foreign income tax (except a tax covered by subsection 832-130(7)).
As the Company and the shareholders are all Australian resident entities for taxation purposes, no distributions made under the Share Buy-Back will give rise to a foreign income tax deduction.
Consequently, section 207-158 and paragraph 207-145(1)(db) of the ITAA 1997 will not apply to deny the shareholders a franking credit gross up and franking credit tax offset in Division 207 when they receive the fully franked Dividend Component of the Share Buy-Back.
Question 7
Summary
The Commissioner will not make a determination under section 45A of the ITAA 1936 or section 45B that section 45C will apply in respect of the Capital Component of the Share Buy-Back.
Detailed reasoning
Sections 45A and 45B of the ITAA 1936 are two anti-avoidance provisions which, if they apply, allow the Commissioner to make a determination that section 45C of the ITAA 1936 applies. The effect of such a determination is that all or part of the distribution of capital received by the shareholder under a share buy-back can be treated as an unfranked dividend.
Section 45A of the ITAA 1936
Section 45A of the ITAA 1936 is an anti-avoidance provision that applies in circumstances where capital benefits are streamed to certain shareholders (the advantaged shareholders) who derive a greater benefit from the receipt of share capital and it is reasonable to assume that the other shareholders (the disadvantaged shareholders) have received or will receive dividends.
The provision of a capital benefit is defined in subsection 45A(3) of the ITAA 1936 to be:
(a) the provision to the shareholder of shares in the company
(b) the distribution to the shareholder of share capital or share premium, or
(c) something that is done in relation to a share that has the effect of increasing the value of a share (which may or may not be the same share) held by the shareholder.
The Share Buy-Back will be a provision of a capital benefit as defined in paragraph 45A(3)(b) of the ITAA 1936 on the basis that the shareholders will receive the Capital Component under the Share Buy-Back.
In order for section 45A of the ITAA 1936 to apply to the Share Buy-Back, the Commissioner must determine that the company streamed capital benefits to its advantaged shareholders who derived a greater benefit from the capital benefits than its disadvantaged shareholders.
Subsection 45A(4) of the ITAA 1936 identifies a number of circumstances where the advantaged shareholders would derive a greater benefit from the capital benefits than the disadvantaged shareholders, as follows:
(a) some or all of the shares in the company held by the shareholder were acquired, or are taken to have been acquired, before 20 September 1985
(b) the shareholder is a non-resident
(c) the cost base (for the purposes of Part IIIAA of the ITAA 1936) of the relevant share is not substantially less than the value of the applicable capital benefit
(d) the shareholder has a net capital loss for the year of income in which this capital benefit is provided
(e) the shareholder is a private company who would not have been entitled to a rebate under former section 46F of the ITAA 1936 if the shareholder had received the dividend that was paid to the disadvantaged shareholder, and
(f) the shareholder has income tax losses.
Under the Share Buy-Back, the shareholders will receive the Capital Component and the Dividend Component, calculated in accordance with the ACPS methodology. It is considered that the shareholders will not receive a greater benefit from receiving the capital benefits for the following reasons:
(a) the shareholders did not acquire their shares in the Company before 20 September 1985
(b) the shareholders are not non-residents
(c) the cost bases of the shares the shareholders hold in the Company are not substantially less than the value of the capital benefits
(d) the shareholders do not have any net capital losses
(e) the shareholders would be entitled to a rebate under former section 46F of the ITAA 1936 as the Dividend Component will be fully franked and as per question 6, a determination has not been made under subdivision 204-D of the ITAA 1997 or 177EA of the ITAA 1936, and
(f) the shareholders do not have any income tax losses.
It is considered that the Company is not discriminating between its the shareholders as the circumstances of the Share Buy-Back indicate that there is no streaming of capital benefits to some shareholders and dividends to other shareholders.
Therefore, the Commissioner will not make a determination under section 45A of the ITAA 1936 that section 45C will apply to the whole, or any part, of the Capital Component of the Share Buy-Back Price to be received by the shareholders.
Section 45B of the ITAA 1936
Subsection 45B(2) of the ITAA 1936 provides that section 45B applies where:
(a) there is a scheme under which a person is provided with a demerger benefit or a capital benefit by a company, and
(b) under the scheme, a taxpayer (the relevant taxpayer), who may or may not be the person provided with the demerger benefit or the capital benefit, obtains a tax benefit, and
(c) 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 a taxpayer (the relevant taxpayer) to obtain a tax benefit.
A scheme' is defined in section 177A of the ITAA 1936 to mean:
(a) any agreement, arrangement, understanding, promise or undertaking, whether express or implied and whether or not enforceable, or intended to be enforceable, by legal proceedings, and
(b) any scheme, plan, proposal, action, course of action or course of conduct.
In this case, the Share Buy-Back would constitute a 'scheme'.
A capital benefit is defined in subsection 45B(5) of the ITAA 1936 as any of the following:
(a) the provision of shares in a company to the person
(b) the distribution to the person of share capital or share premium
(c) something that is done in relation to a share that has the effect of increasing the value of a share (which may or may not be the same share) that is held by the person.
As the shareholders will receive the Capital Component under the Share Buy-Back, it will be provided with a capital benefit in accordance with paragraph 45B(5)(b) of the ITAA 1936. Therefore, the conditions of paragraph 45B(2)(a) are met.
Paragraph 45B(2)(b) of the ITAA 1936 requires that, under the scheme, a taxpayer obtains a tax benefit. Under subsection 45B(9), the shareholders will obtain a tax benefit under the Share Buy-Back if the amount of tax payable by the shareholders in respect of the Share Buy-Back would be less than the amount of tax that would have been payable if the Capital Component of the Share Buy-Back Price had instead been an assessable dividend.
As the cost base of the Company's shares held by the shareholders will be equal to the Capital Component, the shareholders will not make a capital gain upon receipt of the capital benefits, and therefore there will be no tax payable.
If the Capital Component had instead been an assessable dividend, it is expected that the Company would fully frank the dividend as it will have sufficient franking credits. This means those franking credits would no longer be available for use in future income years as they would have been if a capital benefit had been paid instead of a dividend. As explained in paragraph 1.27 of the Explanatory Memorandum to the Taxation Laws Amendment (Company Law Review) Bill 1998 and paragraph 49 of Practice Statement Law Administration 2008/10 Application of section 45B of the Income Tax Assessment Act 1936 to share capital reductions, the preservation of franking credits for the use at a future time (and therefore reduce tax payable in those years) would still constitute a tax benefit within the meaning of subsection 45B(9) of the ITAA 1936.
Therefore, by making a distribution of share capital in circumstances where the Company has available franking credits, the preservation of those franking credits for use at a future time by a shareholder would mean that the shareholders obtain a tax benefit within the meaning of subsection 45B(9) of the ITAA 1936.
Paragraph 45B(2)(c) of the ITAA 1936 provides that it is necessary to have regard to the relevant circumstances of the scheme to determine whether a person or persons entered into the scheme for the purpose of enabling a taxpayer to obtain a tax benefit. The relevant circumstances to be considered are listed in subsection 45B(8).
From consideration of the factors listed in subsection 45B(8) of the ITAA 1936, including those contained in subparagraphs 177D(2)(a) to (h), it is not concluded that the Company will enter into or carry out the Share Buy-Back for the purpose of enabling the shareholders to obtain a tax benefit. The tax benefit that arises to the shareholders is considered to be incidental to the purpose of the Share Buy-Back, which is to facilitate the sale of the business to the Purchaser.
Further, it is considered that the Capital Component of the Share Buy-Back is not attributable to the profits of the Company, nor does the pattern of distributions indicate that the capital benefits to the shareholders is being paid in substitution for a dividend.
Accordingly, the Commissioner will not make a determination under section 45B of the ITAA 1936 that section 45C applies to deem any part of that Capital Component to be an unfranked dividend in the hands of shareholders under the Share Buy-Back.