Edited version of private advice

Authorisation Number: 1052377833044

Date of advice: 27 March 2025

Ruling

Subject: Share buy-back

Question 1:

Will the share buy-back be an off-market purchase within the meaning of paragraph 159GZZZK(d) of the Income Tax Assessment Act 1936[1]?

Answer:

Yes.

Question 2:

Will the share buy-back and subsequent cancellation of the shares bought back be disregarded for the purposes listed in section 159GZZZN?

Answer:

Yes.

Question 3:

Will subsection 159GZZZQ(2) apply to increase or decrease the consideration received by the seller for the selective share buy-back?

Answer:

No, based on the assumption that the buy-back price of $xx,xxx per share was agreed to as a result of real bargaining between the parties dealing at arm's length.

Question 4:

Will the amount of $xxxx per ordinary share, calculated by the "average capital per share" (ACPS) methodology, represent the capital component of the share buy-back price (Capital Component) (being the part of the purchase price which is debited against amounts standing to the credit of Company A share capital account) for the purposes of section 159GZZZP(1)?

Answer:

Yes.

Question 5:

Will the Capital Component of the share buy-back price be taken not to be a dividend pursuant to subsection 159GZZZP(2) of the ITAA 1936?

Answer:

Yes.

Question 6:

Will the dividend component of the share buy-back price (Dividend Component), being the difference between the share buy-back price and the Capital Component per share, be taken to be a dividend that is paid to the sellers out of the retained profits of Company A on the day the buy-back occurs under subsection 159GZZZP(1)?

Answer:

Yes, based on the assumption that the buy-back price of $xxxxx per share was agreed to as a result of real bargaining between the parties dealing at arm's length.

Question 7:

Will the Dividend Component be a frankable distribution pursuant to section 202-40 of the Income Tax Assessment Act 1997 (ITAA 1997) and therefore be capable of being franked pursuant to section 202-5?

Answer:

Yes.

Question 8:

Will the Commissioner make a determination under subsection 45A(2) that section 45C applies in relation to the whole, or any part, of the Capital Component of the share buy-back price for the Company A shares bought back?

Answer:

No.

Question 9:

Will the Commissioner make a determination under paragraph 45B(3)(b) that section 45C applies in relation to the whole, or any part, of the Capital Component of the share buy-back price for the Company A shares bought back?

Answer:

No.

Question 10:

Will the Commissioner make a determination under paragraph 204-30(3)(a) of the ITAA 1997 that a franking debit arises in the franking account of TrussCorp Holdings in relation to the share buy-back?

Answer:

No.

Question 11:

Will the Commissioner make a determination under paragraph 177EA(5)(a) to apply a franking debit to the TrussCorp Holdings franking account in relation to the Dividend Component of the share buy-back price for the Company A ordinary shares bought back?

Answer:

No.

Question 12:

Will the share buy-back give rise to a direct value shift under Division 725 of the ITAA 1997?

Answer:

No.

This private ruling applies for the following period:

Years ended 30 June 20xx and 30 June 20xx

The scheme commences on:

1 July 20xx

Relevant facts and circumstances

Background:

1.  Company A was incorporated on xxxxx. It is a private company and does not have its shares listed for quotation on an official list of a stock exchange in Australia, or elsewhere.

2.  Since June 20xx, the shareholding of Company A is as follows:

Table 1: Shareholding of Company A

3.  Individual C and Individual G are the directors of Company A.

4.  Individual C currently controls xx.xxx% of Company A via:

a.         the C Superannuation Fund, and

b.         Company C

5.  Individual G (exiting party) currently indirectly controls xx.xxx% of Company A via:

a.         the G Superannuation Fund, and

b.         Company B

6.  Family Trust A owns x.xxx% of the shares in Company A.

Financial position of Company A:

7.  The equity in Company A as at 30 June 20xx is as follows:

Table 2: Company A equity as at 30 June 20xx

8.  The retained earnings of Company A as at 31 March 20xx, including retained earnings of TxxxCorp that are available for distribution to TxxxCorp Holdings, are as follows:

Table 3: Retained earnings of Company A as at 31 March 20xx

9.  The franking account balance of Company A is:

Table 4: Franking account balance of Company A as at 31 March 20xx

Proposed arrangement:

10.  Individual G is seeking to exit the business and to cease being a director of Company A. The other shareholders want to retain their and their entities' interests in Company A.

11.  To allow Individual G to exit the business, it is proposed that Company A will undertake a selective buy-back of its ordinary shares. It is proposed that the buy-back will occur as soon as practicable after the issue of this private binding ruling.

12.  On xxx, Valuer A provided a valuation of Company A for the assessment date of 31 March 20xx.

13.  The valuation obtained by Valuer A gave a net share value of $xxx per share. The valuation used the capitalisation of profits[2] method only. It valued Company A as a going concern such that it valued the company in its current form, based on adjusted earnings, and does not incorporate future potential growth.

14.  Negotiations between Individual C and G produced an agreed purchase price of $xxx per share, claiming that this is a reasonable market value and is supported by the valuation. With 132 shares on issue, this purchase price per share represents a value of $xxx for Company A.

15.  The buy-back of the Company A shares held by the Individual G will result in Individual C having control of the company, which will create in-house asset[3] issues for the J Superannuation Fund.

16.  To overcome these in-house asset problems, it is also proposed that the ordinary shares held by the J Superannuation Fund be bought back by the company.

17.  It is proposed that Company A buy-back xx of its ordinary shares for total consideration of $xxx as follows:

a.            xx shares held by the C Superannuation Fund for $xxx

b.            xx shares held by Company B for $xxx, and

c.            xx shares held by the J Superannuation Fund for $xxx.

18.  Company A will then cancel all shares it bought back.

Dividend/Capital Split:

19.  Company A proposes to use the average capital per share (ACPS) methodology to determine the dividend/capital split of the share buy-back price, which will produce an ACPS of $xxx. With xx ordinary shares being bought back, the total capital component will be $xxx. This capital component will be debited from the share capital account, which has a current credit balance of $xxx.

Assumptions:

The answers to the questions raised in this Notice of Private Ruling are based on the following assumptions:

1)            the valuation of Company A prepared by Valuer A dated xxx correctly reflects the market value of the company at the time the transaction is implemented

2)            the agreed purchase price per share under the proposed selective share buy-back has been reached as a result of real bargaining between the parties on an arm's length basis, and

3)            there will be no injections of capital just before the proposed selective share buy-back.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 152-125

Income Tax Assessment Act 1997 Division 200

Income Tax Assessment Act 1997 Section 204-30

Income Tax Assessment Act 1997 Section 202-40

Income Tax Assessment Act 1997 Section 202-45

Income Tax Assessment Act 1997 Section 215-10

Income Tax Assessment Act 1997 section 215-15

Income Tax Assessment Act 1997 section 220-105

Income Tax Assessment Act 1997 Division 725

Income Tax Assessment Act 1997 Subsection 960-120(1)

Income Tax Assessment Act 1936 Section 45A

Income Tax Assessment Act 1936 Section 45B

Income Tax Assessment Act 1936 Section 45C

Income Tax Assessment Act 1936 Division 7A

Income Tax Assessment Act 1936 Division 16K

Income Tax Assessment Act 1936 Subsection 177A(1)

Income Tax Assessment Act 1936 Section 177EA

Reasons for decision

Question 1:

Will the share buy-back be an off-market purchase within the meaning of paragraph 159GZZK(d)?

EFFECT OF BUY-BACKS OF SHARES

20.  Division 16K sets out how share buy-backs are treated for tax purposes. Relevant to the current circumstances, section 159GZZZK provides that where a company buys a share in itself from a shareholder in the company (a share buy-back), the share is not a share that is listed on a stock exchange and the buy-back is not made in the ordinary course of trading on that stock exchange, the buy-back is an off-market purchase.

21.  Practice Statement Law Administration PS LA 2007/9 Share buy-backs (PS LA 2007/9) provides Australian Taxation Office (ATO) staff with guidance about the application of the tax law in relation to on-market and off-market share buy-backs. Paragraph 40 stipulates that to qualify as a share buy-back, it needs to be established that the arrangement is not a corporate reorganisation. Paragraph 40 provides the following examples as potentially not being a share buy-back:

a.            one dominant shareholder buying-out other shareholders

b.            some other change in the underlying ownership of shares in the business

c.            whether part of the business is being sold, and

d.            whether the transaction is between the shareholders.

22.  Paragraph 42 of PS LA 2007/9 further explains that regard should also be had to the reasons for the buy-back and that:

...rationale will go to the purposive tests in the anti-avoidance provisions:

•                     Has the company sold assets/businesses thereby providing capital excess to requirements?

•                     Does the company fail the objective purpose tests in section 45B and section 177D of the ITAA 1936 so as to provide a tax benefit?

•                     Other relevant events or reasons?

Application to your circumstances:

23.  There are currently x shareholders of Company A. A selective share buy-back is proposed to allow Individual G's interests, being the C Superannuation Fund and Company B, to exit the business. Additionally, due to the in-house asset rules, the ordinary shares held by the J Superannuation Fund will be bought back by the company.

24.  After the implementation of the share buy-back, the ordinary shares in Company A will be held by Company C and Family Trust D. The dominant shareholder will be Company C, holding approximately xx% of the ordinary shares, and the minor shareholder will be the trustee of the Family Trust D, holding approximately xx% of the ordinary shares. The change in the proportionate shareholdings is a result of the buy-back and cancellation of xx ordinary shares in Company A rather than due to the introduction of new shareholders.

25.  There is no intention to sell part of the business, or its assets under the arrangement.

26.  The proposed arrangement doesn't appear to be artificial or contrived, nor does it contain any steps to produce a tax benefit otherwise not available. As explained below, it will not fail the anti-avoidance provisions in section 45B and section 177EA. It is to be implemented in a straight-forward manner to the stated purpose of allowing the entities associated with Individual G to exit the Company A.

27.  Considering the factors listed in paragraphs 40 and 42 of PS LA 2007/9, and that Company A is a private company that is not listed on an official stock exchange, the proposed arrangement to buy-back some of its ordinary shares will be an off-market purchase pursuant to section 159GZZZK.

Question 2:

Will the share buy-back and subsequent cancellation of the shares bought back be disregarded for the purposes listed in section 159GZZZN?

BUY-BACK AND CANCELLATION DISREGARDED FOR CERTAIN PURPOSES

28.  Section 159GZZZN provides that where a company buys back a share, the buy-back and cancellation of the share will be disregarded for the purposes of determining whether:

a.            an amount is included in the assessable income of the company (other than the capital gains tax provisions in Part 3-1 or 3-3 of the ITAA 1997)

b.            an amount is allowable as a deduction to the company, or

c.            the company makes a capital gain or loss.

Application to your circumstances:

29.  Under the proposed arrangement, Company A will buy-back and then cancel xx of its ordinary shares. This will satisfy section 159GZZZN and will be disregarded for the purposes of determining whether:

a.            an amount is included in the assessable income of the company (other than the capital gains tax provisions in Part 3-1 or 3-3 of the ITAA 1997)

b.            an amount is allowable as a deduction to the company, or

c.            the company makes a capital gain or loss.

Question 3:

Will subsection 159GZZZQ(2) apply to increase or decrease the consideration received by the seller for the selective share buy-back?

EFFECT OF BUY-BACKS OF SHARES

30.  Section 159GZZZM provides that the purchase price of a share buy-back is the amount of money and/or the market value of any property the shareholder receives as consideration for the buy-back.

Deemed consideration increased or decreased:

31.  For an off-market buy-back, subsection 159GZZZQ(1) provides that, subject to the section:

(a)           In determining, for the purposes of this Act:

(i)         whether an amount is included in the assessable income of the seller under a provision of this Act other than Parts 3-1 and 3-3 of the Income Tax Assessment Act 1997 (about CGT); or

(ii)         whether an amount is allowable as a deduction to the seller; or

(b)           whether the seller makes a capital gain or capital loss;

in respect of the buy-back, the seller is taken to have received or to be entitled to receive, as consideration in respect of the sale of the share, an amount equal to the purchase price in respect of the buy-back.

32.  Where the purchase price for the share in an off-market buy-back is less than its market value[4], subsection 159GZZZQ(2) provides that "subject to subsection (3), in making the determinations mentioned in paragraphs (1)(a) and (b), the amount of consideration that the seller is taken to have received or to be entitled to receive in respect of the sale of the share is equal to the market value mentioned in paragraph (b) of this subsection".

Application to your circumstances:

33.  In order to determine whether subsection 159GZZZQ(2) applies to increase or decrease the consideration received by the seller for the selective share buy-back, it is necessary to establish the market value of the shares in Company A.

34.  On xxx, an independent valuation of Company A was obtained which provided that the ordinary shares had a market value of $xxx per share.

a.            The proposed selective share buy-back has not yet been implemented and the expected date for implementation is not known. Given this, there is potential that the market value of Company A at the time of implementation may differ from that contained in Valuer A's valuation.

b.            The analysis contained herein is based on the assumption that the xxx valuation prepared by Valuer A will continue to correctly reflect the market value of the company at the time of the implementation of the transaction.

35.  You submit that real bargaining at arm's length occurred between Individual C and G such that their negotiations produced an agreed purchase price of $xxx per share, claiming that this is a reasonable market value and is supported by the valuation. Based on the assumption that the valuation remains current at the time of the transaction and that the negotiated price of $xxx represents the market value of the shares, subsection 159GZZZQ(2) will not apply to increase or decrease the amounts received by the sellers.

Question 4:

Will the amount of $xxx per ordinary share, calculated by the "average capital per share" (ACPS) methodology, represent the capital component of the share buy-back price (Capital Component) (being the part of the purchase price which is debited against amounts standing to the credit of Company A share capital account) for the purposes of subsection 159GZZZP(1)?

PART OF OFF-MARKET PURCHASE PRICE IS A DIVIDEND:

36.  Section 159GZZZM outlines how to determine the purchase price of a share buy-back. Relevantly, section 159GZZZM broadly provides that where the seller has received, or is entitled to receive, an amount of money or property as a result of the buy-back, the purchase price will be that amount of money received and/or the market value of the property received (or entitled to receive).

37.  Subject to subsection 159GZZZP(1A), subsection 159GZZZP(1) relevantly provides that where a buy-back of a share by a company is an off-market purchase, a dividend will be taken to have been made by the company to the seller as a shareholder, out of profits of the company and on the day the buy-back occurs. The amount of the dividend is the difference between the purchase price and any part of the purchase price in respect of the buy-back of the share which is debited against amounts standing to the credit of the company's share capital account.

38.  Subsection 159GZZZP(1A) provides that where a dividend is included to any extent in the seller's assessable income of any year, the dividend is not taken into account to that extent under section 118-20 of the ITAA 1997.

39.  Subsection 159GZZZP(2) provides that the remainder of the purchase price is not taken to be a dividend.

Average capital per share method (ACPS):

40. & Paragraph 12 of PS LA 2007/9 provides that the ATO considers that:

... the Average Capital Per Share methodology is the preferred methodology for determining the 'Dividend/Capital Split' in an off-market share buy-back. In the absence of exceptional circumstances, Average Capital Per Share will be applied to determine the capital component...'

41.  Paragraphs 59 and 60 of PS LA 2007/9 further states that:

An essential aspect of any off-market share buy-back is the 'split' between the return of capital and dividend paid to participating shareholders. Section 159GZZZP of the ITAA 1936 prescribes that:

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

•                    the balance of the purchase price is a dividend.

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.

For example, a 'split' that has too low a capital component will both stream dividends and artificially increase capital losses to vendor shareholders. Conversely, a capital component that is too high will provide or stream capital benefits at the expense of dividends. Neither of these outcomes is desirable.

42.  The ACPS method is explained in paragraph 62 of PS LA 2007/9 as 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.

Application to your circumstances:

43.  Company A proposes to use the ACPS methodology to determine the capital/dividend split of the purchase price of the TrussCorp Holdings shares under the proposed arrangement. This will require dividing the company's issued share capital by the number of shares on issue to determine the capital component of the buy-back price. The balance of the buy-back price will be the amount of the dividend per share.

44.  With issued share capital of $xxx and xxx issued shares, the capital component of the buy-back price for the purposes of subsection 159GZZZP(1) using the ACPS method is $xxx per share.

Question 5:

Will the capital component of the share buy-back price be taken not to be a dividend pursuant to subsection 159GZZZP(2)?

PURCHASE PRICE NOT A DIVIDEND:

45.  As explained above, subsection 159GZZZP(2) provides that the remainder off-market purchase price not covered by subsections 159GZZZP(1) and (1A) will not be taken to be a dividend.

Application to your circumstances:

46.  Under the proposed arrangement, the part of the purchase price representing the capital component, being $xxx per share, will be debited against the share capital account.

47.  In this case, the amount not covered by subsections 159GZZZP(1) and (1A) is the capital component of $xxx per share. As such, subsection 159GZZZP(2) will apply such that the amount of $xxx per share will not be taken to be a dividend

Question 6:

Will the Dividend Component of the share buy-back price, being the difference between the share buy-back price and the Capital Component per share, be taken to be a dividend that is paid to the sellers out of the retained profits of TrussCorp Holdings on the day the buy-back occurs under subsection 159GZZZP(1)?

PART OF THE OFF-MARKET PURCHASE PRICE IS A DIVIDEND:

48.  As explained above, subject to subsection 159GZZZP(1A), subsection 159GZZZP(1) provides that the dividend component of an off-market buy-back will be the difference between the purchase price and any amount of the purchase price in respect of the buy-back of the share which is debited against amounts standing to the credit of the company's share capital account.

Application to your circumstances:

49.  As explained above, assuming that the share buy-back price of $xxx per share represents the market value of the shares at the time the proposed arrangement is implemented, the dividend component of the buy-back price pursuant to subsection 159GZZZP(1) will be the difference between the buy-back price and the capital component, being an amount of $xxx per share.

Question 7:

Will the Dividend Component be a frankable distribution pursuant to section 202-40 of the Income Tax Assessment Act 1997 (ITAA 1997) and therefore be capable of being franked pursuant to section 202-5?

FRANKABLE DISTRIBUTIONS:

50.  Section 202-40 of the ITAA 1997 provides that a distribution is a frankable distribution to the extent that it is not unfrankable pursuant to section 202-45.

51.  In relation to a company, the meaning of the term 'distribution' is provided by item 1 of the table in subsection 960-120(1) of the ITAA 1997 as "a dividend, or something that is taken to be a dividend, under this Act".

52.  Section 202-45 of the ITAA 1997 states that the following are unfrankable:

...

(c)           where the purchase price on the buy-back of a share by a company from one of its members is taken to be a dividend under section 159GZZZP of that Act - so much of that purchase price as exceeds what would be the market value (as normally understood) of the share at the time of the buy-back if the buy-back did not take place and were never proposed to take place;

(d)           a distribution in respect of a non-equity share;

(e)           a distribution that is sourced, directly or indirectly, from a company's share capital account;

(f)           an amount that is taken to be an unfrankable distribution under section 215-10 or 215-15;

(g)           an amount that is taken to be a dividend for any purpose under any of the following provisions:

(i)         unless subsection 109RB(6) or 109RC(2) applies in relation to the amount - Division 7A of Part III of that Act (distributions to entities connected with a private company);

(ii)         (Repealed...)

(iii)         section 109 of that Act (excessive payments to shareholder, directors and associates)

(iv)         section 47A of that Act (distribution benefits - CFCs)

(h)           an amount that is taken to be an unfranked dividend for any purpose;

(i)         under section 45 of that Act (streaming bonus shares and unfranked dividends);

(ii)         because of a determination of the Commissioner under section 45C of that Act (streaming dividends and capital benefits);

(i)            a demerger dividend;

(j)            a distribution that section 152-125 or 220-105 says is unfrankable.

Section 215-10 of the ITAA 1997 - Certain non-share dividends by ADIs unfrankable:

53.  Section 215-10 of the ITAA 1997 provides conditions for when non-share dividends[5] paid by an authorised deposit-taking institution (ADI) will not be frankable.

Section 215-15 of the ITAA 1997 - Non-share dividends are unfrankable if profits are unavailable:

54.  Broadly, section 215-15 of the ITAA 1997 provides that if a corporate tax entity pays a non-share dividend and immediately before the payment, the available frankable profits of the entity is nil or less than nil, the non-share dividend will be unfrankable.

Division 7A - Distributions to entities connected with a private company - deemed dividends:

55.  Broadly, Division 7A is an integrity measure aimed at ensuring that profits of a private company are not effectively received by its shareholders in non-dividend form. The general provisions of Division 7A treat amounts paid or lent, or debts forgiven, by a private company to a shareholder in a private company or an associate of such a shareholder as unfranked dividends.

56.  Subsection 109RB(6) relates to where the Commissioner has decided to exercise his discretion to either disregard the operation of Division 7A or to allow the deemed dividend to be franked.

57.  Section 109RC relates to dividends which are taken to have been paid as a result of a family law obligation.

Section 45 - Streaming bonus shares and unfranked dividends:

58.  Broadly, section 45 relates to the provision of shares and the payment of minimally franked dividends to its shareholders in such a way that the shares are not received by all shareholders or will receive minimally franked dividends.

Section 152-125 of the ITAA 1997 - payments to company's or trust's CGT concession stakeholders are exempt:

59.  Section 152-125 provides that if a capital gain made by a company or trust is disregarded under the 15 year exemption in section 152-110 of the ITAA 1997, certain payments by the company or trust to an individual are not taken into account in determining that individual's taxable income.

Section 220-105 of the ITAA 1997 - Unfrankable distributions by XX franking companies:

60.  Broadly, section 220-105 provides the conditions when franking credits will not be available to a XX franking company.

Application to your circumstances:

61.  Assuming the valuation remains correct and applicable at the time the arrangement is implemented and the purchase price per share of $xxx is the market value, there is no amount that is in excess of what would have been the market value and paragraph 202-45(c) will not apply.

62.  The proposed arrangement is in relation to a buy-back of Company A's ordinary shares and therefore, does not involve a distribution in respect of a non-equity share for paragraph 202-45(d) to apply.

63.  The capital component of $xxx per share will be sourced directly from Company A's share capital account. Consequently, paragraph 202-45(e) will apply to this portion of the share purchase price and will not be frankable.

64.  Additionally, the proposed buy-back of Company A's shares will not involve:

a.            the payment of non-share dividends (sections 215-10 and 215-15 will not apply)

b.            a deemed dividend (subsections 109RB(6) and 109RC(2) will not apply)

c.            excessive payments by the company to an associated person (section 109 will not apply)

d.            a distribution to a controlled foreign company (CFC) (section 47A will not apply)

e.            the Commissioner making a determination under subsection 45A(2) or 45B(3), explained in paragraph 75 (section 45C will not apply)

f.            the restructuring of a corporate group under a demerger

g.            a capital gain made by the company that is disregarded under section 152-110 (section 152-125 will not apply), and

h.            a XX franking company (section 220-105 will not apply).

65.  Consequently, the amount of the purchase price in excess of the capital component of $xxx per share will be frankable pursuant to section 202-40 of the ITAA 1997.

Question 8:

Will the Commissioner make a determination under subsection 45A(2) that section 45C applies in relation to the whole, or any part, of the Capital Component of the share buy-back price for the Company A shares bought back?

EXPLANATION OF THE LEGISLATION:

66.  In 1998, amendments were made to the Corporations Act 2001 (Corporations Act) which removed some of the then existing restrictions on share capital reductions by companies. A consequence of these amendments was that it became easier for companies to make capital distributions to shareholders.

67.  As a result of the changes to the Corporations Act, sections 45A, 45B and 45C were introduced as anti-avoidance provisions to prevent companies from distributing profits to shareholders as preferentially taxed capital distributions rather than dividends.

Streaming of dividends and capital benefits:

68.  Paragraph 95 of PS LA 2007/9 explains that '[s]ection 45A of the ITAA 1936 applies where a company streams the provision of capital benefits and the payment of dividends in such a way that capital benefits are received by 'advantaged shareholders' who thereby derive a greater benefit from the capital benefits than other shareholders (who receive dividends)'.

69.  Specifically, section 45A provides that where a company:

...streams the provision of capital benefits and the payment of dividends to its shareholders in such a way that:

(a)          the capital benefits are, or apart from this section would be, received by shareholder (the advantaged shareholders) who would, in the year of income in which the capital benefits are provided, derive a greater benefit from the capital benefits than other shareholders; and

(b)          it is reasonable to assume that the other shareholders (the disadvantaged shareholders) have received, or will receive, dividends.

70.  The Commissioner may make a determination in writing that section 45C applies to whole or part of the capital benefit pursuant to subsection 45A(2).

71.  Subsection 45A(3) provides that the term 'provision of a capital benefit' refers to the following:

a.            the provision of shares in the company to the shareholder

b.            the distribution of share capital or share premium to the shareholder, or

c.            something that is done in relation to a share that increases the value of a share held by the shareholder.

72.  Subsection 45A(4) describes when a 'greater benefit' arises:

The circumstances in which a shareholder would, in a year of income, derive a greater benefit from capital benefits than another shareholder include, but are not limited to, any of the following circumstances existing in relation to the first shareholder and not in relation to the other shareholder:

(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 IIIA) 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 if the shareholder had received the dividend that was paid to the disadvantaged shareholder;

(f)          the shareholder has income tax losses.

73.  Section 45C broadly provides that if the Commissioner makes a determination under subsections 45A(2), the amount of the capital benefits is taken to be paid out of company profits and to be an unfranked dividend that is paid by the company to the shareholder or relevant taxpayer at the time the capital benefit is provided.

Application to your circumstances:

74.  Consistent with paragraph 45A(3)(b), the 3 exiting shareholders will receive a distribution of share capital and therefore Company A will provide them with a capital benefit of $xxx per share.

75.  The cost base of the 13 Company A shares held by each of the C Superannuation Fund and the J Superannuation Fund is $xxx per share. The cost base of these shares is not substantially less than the capital benefit of $xxx such the Superannuation Funds would not receive a greater benefit under paragraph 45B(4)(c).

76.  The 50 shares held by Company B have a cost base of $1 per share [6], being substantially less than the $xxx capital benefit per share. As the cost base is substantially less than the capital benefit, Company B will receive a greater benefit from the capital benefit in accordance with subsection 45A(4).

77.  However, the proposed arrangement does not involve the payment of dividends to the remaining shareholders per subsection 45A(1). Additionally, Company A will use the ACPS methodology to determine the capital/dividend split of the purchase price which will produce a capital component of $xxx per share for the purposes of subsection 159GZZZP(1). As stated in paragraph 62 of PS LA 2007/9, the use of the ACPS method gives a strong presumption that section 45A would not apply to the buy-back. Given this, the Commissioner will not make a determination pursuant to subsection 45A(2) that section 45C will apply in relation to all or part of the capital benefits.

Question 9:

Will the Commissioner make a determination under paragraph 45B(3)(b) that section 45C applies in relation to the whole, or any part, of the Capital Component of the share buy-back price for the Company A shares bought back?

EXPLANATION OF THE LEGISLATION

Schemes to provide certain benefits:

78.  Broadly, section 45B applies to schemes where a 'capital benefit' is provided for a 'more than incidental purpose' of conferring a tax benefit. As explained in paragraph 100 of PS LA 2009/7, the application of section 45B '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'.

79.  Specifically, subsection 45B(1) provides that the purpose of section 45B is to ensure that relevant amounts are treated as dividends if certain payments, allocations and distributions are made in substitution for dividends.[7]

80.  In relation to capital benefits, subsection 45B(2) provides that 45B will apply if:

a.            there is a scheme under which a person is provided with a capital benefit by a company

b.            a taxpayer (the relevant taxpayer) obtains a tax benefit (this taxpayer may or may not be the person who is provided with the capital 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 the taxpayer (the relevant taxpayer) to obtain a tax benefit.

81.  A 'scheme' is defined in subsection 177A(1) as:

(a)          any agreement, arrangement, understanding, promise or undertaking, whether express or implied and whether or not enforceable, or intended to be enforceable by legal process; and

(b)          any scheme, plan, proposal, action, course of action or course of conduct.

82.  Subsection 45B(5) provides that a person will be 'provided with a capital benefit' if:

a.            they are provided with an ownership interest in a company

b.            they receive distributions of share capital or share premium, or

c.            something is done that increases the value of their ownership interest (which may or may not be the same ownership interest).

83.  Subsection 45B(7) further states that a non-share distribution to an equity holder will be taken to be a distribution of share capital to the equity holder to the extent to which it is a non-share capital return.

84.  In relation to capital benefits, the meaning of the term 'tax benefit' is provided by subsection 45B(9), which states:

A relevant taxpayer obtains a tax benefit if an amount of tax payable, or any other amount payable under this Act, by the relevant taxpayer would, apart from this section, be less than the amount that would have been payable, or would be payable at a later time than it would have been payable, if the ... capital benefit had been an assessable dividend.

85.  Paragraph 45B(2)(c) requires the Commissioner to consider the 'relevant circumstances' of the scheme as set out in subsection 45B(8). A consideration of these circumstances determines whether any part of the scheme will be entered into for a purpose, other than an incidental purpose, of enabling the relevant taxpayer to obtain a tax benefit. Each of the circumstances must be considered in order to determine whether or not, individually or collectively, they reveal the existence of the requisite purpose.

86.  The test of purpose is an objective one. The question is whether it would be concluded that a person who enters into or carries out the scheme does so for the purpose of obtaining a tax benefit for the relevant taxpayer in respect of the capital benefit. The purpose does not have to be the most influential or prevailing purpose, but it must be more than an incidental purpose.

87. & The relevant circumstances contained in subsection 45B(8) cover the circumstances of the company and the tax profile of the shareholders, and include:

(a)          the extent to which the demerger benefit or capital benefit is attributable to capital or the extent to which the demerger benefit or capital benefit is attributable to profits (realised and unrealised) of the company or of an associate (within the meaning in section 318) of the company;

(b)          the pattern of distributions of dividends, bonus shares and returns of capital or share premium by the company or by an associate (within the meaning in section 318) of the company:

(c)          whether the relevant taxpayer has capital losses that, apart from the scheme, would be unutilised (within the meaning of the Income Tax Assessment Act 1997) at the end of the relevant year of income;

(d)          whether some or all of the ownership interests in the company or in an associate (within the meaning in section 318) of the company held by the relevant taxpayer were acquired, or are taken to have been acquired, by the relevant taxpayer before 20 September 1985;

(e)          whether the relevant taxpayer is a non-resident;

(f)          whether the cost base (for the purposes of the Income Tax Assessment Act 1997) of the relevant ownership interest is not substantially less than the value of the applicable demerger benefit or capital benefit;

(g)          (Repealed by No 101 of 2006)

(h)          if the scheme involves the distribution of share capital or share premium - whether the interest held by the relevant taxpayer after the distribution is the same as the interest would have been if an equivalent dividend had been paid instead of the distribution of share capital or share premium;

(i)          if the scheme involves the provision of ownership interests and the later disposal of those interests; or an increase in the value of ownership interests and the later disposal of those interest:

(i)        the period for which the ownership interests are held by the holder of the interests; and

(ii)        when the arrangement for the disposal of the ownership interests was entered into;

(j)          for a demerger only:

(i)        [not relevant for the current circumstances]...

(k)          any of the matters referred to in subsection 177D(2).

88.  PS LA 2007/9 states that the use of the ACPS method to determine the capital and dividend components of a share buy-back "gives rise to a strong presumption that section 45A and 45B of the ITAA 1936 would not apply to the buy-back".

Effect of determinations under section 45A and 45B for capital benefits:

89.  Section 45C broadly provides that if the Commissioner makes a determination under subsections 45B(3), the amount of the capital benefits is taken to be paid out of company profits and to be an unfranked dividend that is paid by the company to the shareholder or relevant taxpayer at the time the capital benefit is provided.

Application to your circumstances:

90.  The proposed arrangement for the selective buy-back of the shares in Company A is an agreement, arrangement or understanding and therefore satisfies the definition of a scheme pursuant to subsection 177A(1).

91.  As previously discussed, the 13 Company A shares held by the two superannuation funds have a cost base that will be greater than the capital component per share such that the funds will not receive a capital benefit and therefore, will not receive a tax benefit, under the proposed arrangement.

92.  Conversely, the cost base of the shares held by Company B are substantially less than the capital benefit to be provided (paragraph 45B(8)(f)) and the company will receive a capital benefit from the proposed arrangement. As the 50 shares have been held by Company B for greater than 12 months, company will be entitled to at least the 50% discount on the capital gain. Alternatively, if Company B were to receive a dividend, the company would be liable to a greater amount of tax. Consequently, Company B will receive a tax benefit under subsection 45B(9) and paragraph 45B(2)(b) is satisfied. However, despite this:

a.            the capital benefits will not be attributable to realised or unrealised profits of Company A

b.            the dividend policy of Company A will not be impacted by the proposed arrangement

c.            the shares were acquired after 20 September 1985

d.            all shareholders to participate in the proposed arrangement are Australian residents

e.            the interests held by the participating shareholders will not be the same if a dividend is instead paid.

93.  Having regard to the relevant circumstances as provided in subsection 45B(8), it is considered that the tax benefit from carrying out the scheme will be incidental. Therefore, it is not considered that the parties will enter into the scheme for purpose of enabling Company B to obtaining a tax benefit. Consequently, paragraph 45B(2)(c) will not be satisfied. Moreover, in accordance with PS LA 2009/7, the use of the ACPS methodology to determine the capital/dividend split will give "rise to a strong presumption that section 45A and 45B of the ITAA 1936 would not apply to the buy-back" and the Commissioner will not make a determination that section 45C to the resultant tax benefit.

Question 10:

Will the Commissioner make a determination under paragraph 204-30(3)(a) of the ITAA 1997 that a franking debit arises in the franking account of Company A in relation to the share buy-back?

STREAMING DISTRIBUTIONS:

94.  Division 200 of the ITAA 1997 provides for an imputation system to avoid double taxation at the shareholder level. Broadly, this is achieved by allowing members who receive assessable income from a corporate tax entity to claim a tax offset, or a refund if the member is unable to fully utilise the tax offset, for tax already paid by the corporate entity. The tax credit paid by the corporate tax entity is known as a franking credit.

95.  Section 204-30 of the ITAA 1997 applies where a company streams the payment of franked distributions to its shareholders in such a way that the imputation benefits attaching to the distribution are received by those shareholders who derive a greater benefit from them and other shareholders receive lesser imputation benefits, or no imputation benefits.

96.  Specifically, subsection 204-30(1) of the ITAA 1997 provides that:

This section empowers the Commissioner to make determinations if an entity streams one or more distributions (or one or more distributions and the giving of other benefits), whether in a single franking period or in a number of franking periods, 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.

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.

97.  The meaning of the term 'streams' is not defined in the income tax legislation. Guidance on the meaning of the term can be found in the Explanatory Memorandum to the New Business Tax System (Imputation) Bill 2002, which introduced the streaming provisions in Subdivision 204-D. It states that streaming will occur when 'selectively directing the flow of franked distributions to those members who can most benefit from imputation credits'.

98.  Paragraphs 3.29 and 3.30 of the Explanatory Memorandum further state:

3.29 It will normally be apparent on the face of an arrangement that a strategy for streaming is being implemented. The distinguishing of members on the basis of their ability to use franking benefits is a key element of streaming.

3.30 Where one class [of members] is predominantly able to use imputation credits, and the other is predominantly not, it may be apparent that an arrangement is streaming, notwithstanding the presence in each class of a small minority of the other type of member.

99.  Examples of what would be the giving of other benefits is given for in subsection 204-30(2) of the ITAA 1997, which provides:

(a)          issuing bonus shares;

(b)          returning paid-up capital;

(c)          forgiving a debt; the entity or another entity making a payment of any kind, or giving any property, to a member or to another person on a member's behalf.

100.  Subsection 204-30(3) of the ITAA 1997 then provides that the Commissioner may make, in writing, one or more determinations:

(a)          that a specified franking debit arises in the franking account of the entity, for a specified distribution or other benefit to a disadvantage member;

(b)          that a specified exemption debit arises in the exempting account of the entity, for a specified distribution or other benefit to a disadvantaged member;

(c)          that no imputation benefit is to arise in respect of a distribution that is made to a favoured member and specified in that determination.

101.  As explained in paragraph 139 of PS LA 2007/9, subsection 204-30(4) and (5) provide how the debit or distribution may be specified, as follows:

•                     the Commissioner may specify the franking percentage or exempting percentage to be used in working out the amount of the debit, or

•                     specify the date or period when the distribution was made, and the member or class of members to whom it was made.

102.  Subsection 204-30(6) of the ITAA 1997 explains that a member of an entity will receive an imputation benefit if:

(a)          the member is entitled to a tax offset under Division 207 as a result of the distribution; or

(b)          an amount would be included in the member's assessable income as a result of the distribution because of the operation of section 207-35; or

(c)          a franking credit would arise in the franking account of the member as a result of the distribution; or

(d)          an exempting credit would arise in the exemption account of the member as a result of the distribution; or

(e)          the member would not be liable to pay withholding tax on the distribution, because of the operation of paragraph 128B(3)(ga) of the Income Tax Assessment Act 1936; or

(f)          the member is entitled to a tax offset under section 210-170 as a result of the distribution.

103.  Subsections 204-30(7) and (8) of the ITAA 1997 provide a non-exhaustive list of cases which would result in a favoured member deriving a greater benefit from franking credits, if:

(a)          the other member is a foreign resident;

(b)          the other member would not be entitled to any tax offset under Division 207 because of the distribution;

(c)          the amount of the income tax that, apart from this Division, would be payable by the other member because of the distribution is less than the tax offset to which the other member would be entitled;

(d)          the other member is a corporate tax entity at the time of the distribution is made, but no franking credit arises for the entity as a result of the distribution;

(e)          the other member is a corporate tax entity at the time of the distribution is made, but cannot use franking credits received on the distribution to frank distributions to its own members because:

(i)        it is not a franking entity; or

(ii)        it is unable to make frankable distributions;

(f)          the other member is an exempting entity.

104.  Where the Commissioner has or will exercise his discretion in relation to the same arrangement, paragraph 142 of PS LA 2007/9 states that the Commissioner will generally not make a determination pursuant to subsection 204-30(3) of the ITAA 1997 where he intends to exercise his discretion pursuant to section 177EA.

Application to your circumstances:

105.  Under the proposed arrangement, the dividend component of the buy-back price for the shares in Company A will be $xxx per ordinary share. In order for section 204-30 of the ITAA 1997 to apply, there needs to be an advantaged shareholder who receives a greater benefit from the franking credit.

106.  In the proposed arrangement, there will not be an advantaged shareholder who will receive a greater benefit from the franking credits than another member. Consequently, section 204-30 of the ITAA 1997 will not apply and the Commissioner will not make a determination pursuant to paragraph 204-30(3)(a).

Question 11:

Will the Commissioner make a determination under paragraph 177EA(5)(a) to apply a franking debit to the Company A franking account in relation to the Dividend Component of the share buy-back price for the ordinary shares bought back?

CREATION OF FRANKING DEBIT OR CANCELLATION OF FRANKING CREDITS:

Explanation of the legislation

107.  Section 177EA is a general anti-avoidance provision relating to a wide range of schemes designed to obtain imputation benefits. The Explanatory Memorandum to the Taxation Laws Amendment Bill (No. 3) 1998 (Explanatory Memorandum), which introduced section 177EA, states:

8.5 Two of the underlying principles of the imputation system are, firstly, that the benefits of imputation should only be available to the true economic owners of shares, and only to the extent that those taxpayers are able to use the franking credits themselves and, secondly, that tax paid at the company level is in broad terms imputed to shareholders proportionately to their shareholdings.

108.  Section 177EA 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 share or an interest in shares, and could include an off-market share buy-back with a franked dividend component. Specifically, subsection 177EA(3) provides that:

This section 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.

109.  Consequently, having regard to the relevant circumstances of the particular scheme, section 177EA focusses on whether it can be concluded that there is a more than incidental purpose of conferring an imputation benefit under the scheme for the company, its shareholder/s or any relevant party.

110.  The meaning of the term 'relevant circumstances' is provided in subsection 177EA(17) to include:

(a)          the extent and duration of the risks of loss, and the opportunities for profit or gain, from holding membership interests, or having interests in membership interests, in the corporate tax entity that are respectively borne by or accrue to the parties to the scheme, and whether there has been any change in those risks and opportunities for the relevant taxpayer or any other party to the scheme (for example, a change resulting from the making of any contract, the granting of any option or the entering into of any arrangement with respect to any membership interests, or interests in membership interests, in the corporate tax entity);

(b)          whether the relevant taxpayer would, in the year of income in which the distribution is made, or if the distribution flows indirectly to the relevant taxpayer, in the year in which the distribution flows indirectly to the relevant taxpayer, derive a greater benefit from franking credits than other entities who hold membership interests, or have interests in membership interests, in the corporate tax entity;

(c)          whether, apart from the scheme, the corporate tax entity would have retained the franking credits or exempting credits or would have used the franking credits or exempting credits to pay a franked distribution to another entity referred to in paragraph(b);

(d)          whether, apart from the scheme, a franked distribution would have flowed indirectly to another entity referred to in paragraph(b);

(e)          if the scheme involves the issue of a non - share equity interest to which section 215-10 of the Income Tax Assessment Act 1997 applies--whether the corporate tax entity has issued, or is likely to issue, equity interests in the corporate tax entity:

(i)        that are similar, from a commercial point of view, to the non - share equity interest; and

(ii)        distributions in respect of which are frankable;

(f)          whether any consideration paid or given by or on behalf of, or received by or on behalf of, the relevant taxpayer in connection with the scheme (for example, the amount of any interest on a loan) was calculated by reference to the imputation benefits to be received by the relevant taxpayer;

(g)          whether a deduction is allowable or a capital loss is incurred in connection with a distribution that is made or that flows indirectly under the scheme;

(ga)          whether a distribution that is made or that flows indirectly under the scheme to the relevant taxpayer is sourced, directly or indirectly, from unrealised or untaxed profits;

(h)          whether a distribution that is made or that flows indirectly under the scheme to the relevant taxpayer is equivalent to the receipt by the relevant taxpayer of interest or of an amount in the nature of, or similar to, interest;

(i)          the period for which the relevant taxpayer held membership interests, or had an interest in membership interests, in the corporate tax entity;

(j)          any of the matters referred to in subsection 177D(2).

111.  Paragraph 115 of PS LA 2007/9 states:

In coming to the conclusion that section 177EA of the ITAA 1936 does apply to an off-market share buy-back, the Commissioner has regard to relevant circumstances of an arrangement, as outlined in subsection 177EA(17). Tax officers should be aware of even seemingly innocuous features that have caused the provision to be applied:

•                     the delivery of franking credits in excess of what would have otherwise been distributed in the ordinary course of dividend declaration

•                     the greater attraction of the buy-back to resident shareholders who could fully utilise the franking credits than to non-resident shareholders who could not (...)

•                     the greater attraction of the buy-back to some resident shareholders with a low marginal tax rate than other resident shareholders (for example, whereas superannuation funds are taxed at 15% and corporations at 30% individuals can be taxed at a marginal tax rate up to 45%), and

•                     that participating shareholders were more likely than not to make an economic gain, but a loss for taxation purposes, from their participation.

112.  However, paragraph 103[8] of PSLA 2007/9 provides that:

A more than incidental purpose includes the 'main or substantial purpose' but does not need to be the most' influential or prevailing purpose' and will not include a purpose which occurs 'fortuitously or in subordinate conjunction with one of the main or substantial purposes...or merely follows that purpose as a natural incident.'

113.  Where section 177EA applies, subsection 177EA(5) provides that the Commissioner may make a determination in writing that:

a.            where the corporate tax entity is a party to the scheme - the franking debit or exempting debit of the entity arises in respect of each distribution made to the relevant taxpayer, or that flows indirectly to the relevant taxpayer, or

b.            no imputation benefit is to arise in respect of a distribution or a specified part of a distribution that is made, or that flows indirect, to the relevant taxpayer.

114.  A determination made by the Commissioner in accordance with subsection 177EA(5) will not form part of an assessment.

Application to your circumstances:

115.  Given the broad drafting of paragraphs 177EA(3)(a) to (d), these paragraphs will be satisfied under the proposed selective share buy-back arrangement. Therefore, whether the Commissioner will make a determination pursuant to subsection 177EA(5) will fall upon the consideration of the 'relevant circumstances' of the proposed share buy-back arrangement and if it can be concluded that there is more than an incidental purpose of providing a franking credit benefit.

a.            Paragraph 177EA(17)(a):

             i.        Company A was incorporated in 20xx and the shareholding of the company has not changed since 20xx.

             ii.        Given the above, the proposed share buy-back does not appear to contain elements that would mitigate or alter the risks of loss or give rise to additional opportunities for profit or gain, that have not been present over the last almost xx years.

b.            Paragraph 177EA(17)(b):

             i.        There are no non-resident shareholders. However, xx of the shares proposed to be bought back are held by superannuation funds, in relation to which franking credits may be able to be used to offset tax payable by the funds and to claim refundable tax offsets for any excess franking credits.

             ii.        Despite this, any greater benefit received by the superannuation funds as a result of the proposed share buy-back will be a subordinate conjunction or follow as a natural incident of the main or substantial purpose of the buyback. There is not a more than incidental purpose of enabling any taxpayer to receive a franking benefit.

c.            Paragraph 177EA(17)(c) and (d):

             i.        The franked distribution will not flow indirectly to a different entity than those of the scheme if the proposed arrangement is not implemented.

d.            Paragraph 177EA(17)(e):

             i.        Section 215-10 of the ITAA 1997 broadly applies to an authorised deposit-taking institution (ADI). There are no ADIs involved in the arrangement and paragraph 177EA(17)(e) is not applicable.

e.            Paragraph 177EA(17)(f):

             i.        No consideration will be paid to the shareholders (or related parties) with reference to the franking credits received by the shareholders.

f.             Paragraph 177EA(g):

             i.        The cost bases of the relevant shares range from $xxx (xx shares) to $xxx (xx shares) per share.

             ii.        The capital component of the purchase price is $xxx per share. Therefore, the buy-back of xx of the shares will produce a capital loss of $xxx per share for certain taxpayers.

g.            Paragraph 177EA(ga):

             i.        Based on the valuation provided, consideration of $xxx will be paid for the proposed buy-back of xx of shares.

             ii.        As at 31 March 20xx, Company A had retained profits of $xxx being sufficient to pay the consideration from taxed profits.

h.            Paragraph 177EA(h):

             i.        None of the consideration will be equivalent to the receipt of an interest (or an amount in the nature of, or similar to, interest) by the shareholder.

i.              Paragraph 177EA(i):

             i.        The shareholding of Company A has remained unchanged since 20xx.

             ii.        No shareholders will have purchased shares in the company immediately before the proposed share buy-back arrangement.

j.            Paragraph 177EA(j) - matters in subsection 177D(2):

             i.        The form and substance of the scheme does not appear to be artificial or contrived but rather is being contemplated as an option to allow Individual G (and his related entities) to exit the business.

             ii.        The scheme does not appear to be motivated to enable a franking credit benefit.

116.    Based on the above summary analysis, the Commissioner will not make a determination pursuant to subsection 177EA(5) to deny franking credits on the dividend component received under a proposed share buy-back arrangement.

Question 12:

Will the share buy-back give rise to a direct value shift under Division 725 of the ITAA 1997?

GENERAL VALUE SHIFTING REGIME

117.  The general value shifting regime in Part 3-95 of the ITAA 1997 addresses arrangements that shift value out of assets, distorting the relationship between their market values and their values for tax purposes. Without a value shifting regime, these arrangements could encourage the creation of artificial losses and the deferring of gains.

DIVISION 725 - DIRECT VALUE SHIFTING

118.  The direct value shifting rules within Division 725 of the ITAA 1997 apply to assets that are directly affected by a value shift. Broadly, a direct value shift happens where something is done that results in a decrease in the market value of an asset, usually with a resulting increase in the market value of another asset.

119.  Where there is a direct value shift involving the equity or loan interests in a target entity, for which the threshold conditions in section 725-50 of the ITAA 1997 are satisfied, there may be consequences under Division 725.

120.  To determine when there is a direct value shift, subsection 725-145(1) of the ITAA 1997 provides:

There is a direct value shift under a scheme involving equity or loan interests in an entity (the target entity) if:

a)            there is a decrease in the market value of one or more equity or loan interests in the target entity;

b)            the decrease is reasonably attributable to one or more things done under the scheme, and occurs at or after the time when that thing, or the first of those things, is done; and

c)            either or both of subsections (2) and (3) are satisfied.

121.  Relevantly, subsections 725-145(2) and 725-145(3) of the ITAA 1997 provide:

725-145(2): One or more equity or loan interests in the target entity must be issued at a discount. The issue must be, or must be reasonably attributable to, the thing, or one or more of the things, referred to in paragraph (1)(b). It must also occur at or after the time referred to in that paragraph.

725-145(3): Or, there must be an increase in the market value of one or more equity or loan interests in the target entity. The increase must be reasonably attributable to the thing, or to one or more of the things, referred to in paragraph (1)(b). It must also occur at or after the time referred to in that paragraph.

122.  An equity or loan interest will be issued at a discount if the market value of the interest when issued exceeds the amount of the payment that the issuing entity receives, per subsection 725-150(1) of the ITAA 1997. The excess is the amount of the discount.

123.  In considering whether the three paragraphs under subsection 725-145(1) of the ITAA 1997 are satisfied, the following terms must also be considered:

a.            'scheme'

b.            'equity or loan interests', and

c.            'target entity'.

Meaning of the term 'scheme'

124.  The meaning of the term 'scheme' is explained in above.

Meaning of the term 'equity or loan interests'

125.  The term 'equity or loan interests' takes its meaning from subsection 727-520(1) of the ITAA 1997 which provides that 'an equity or loan interest in an entity is a primary interest, or a secondary interest, in the entity.'

a.            A primary interest in an entity is a primary equity interest, or a primary loan interest, in the entity, per subsection 727-520(2) of the ITAA 1997.

b.            A primary equity interest in a company means 'a share in the company...', per table 1 of subsection 727-520(3) of the ITAA 1997.

c.            a 'share' in the company means 'a share in the capital of the company, and includes stock', per subsection 995-1(1) of the ITAA 1997.

Application to your circumstances

Scheme

126.  To allow for the exit of Individual G's controlled entities from the business, as well as the J Superannuation Fund, it is proposed that Company A will buy-back 76 of its ordinary shares, comprising:

a.            xx shares held by the C Superannuation Fund for $xxx

b.            xx shares held by Company B for $xxx, and

c.            xx shares held by the J Superannuation Fund for $xxx.

127.  Company A will then cancel all shares it bought back.

128.  If implemented, the buy-back and cancellation of the xx shares will constitute agreements, arrangements, understandings, promises and the like, and as such, be a scheme for the purposes of subsection 995-1(1) of the ITAA 1997.

Equity or loan interests

129.  The xx ordinary shares in Company A are shares in a company and therefore are primary equity interests pursuant to item 1 of the table in subsection 727-520(3) of the ITAA 1997. Given this, these shares are primary interests within the meaning of subsection 727-520(2).

130.  However, the proposed arrangement does not involve the issue of an equity interest in Company A at a discount such that subsection 725-145(2) of the ITAA 1997 is not satisfied. Nor does the proposed arrangement involve an increase in the market value of one or more of the equity interests, such that subsection 725-145(3) will not be satisfied. As a result, a direct value shift pursuant to subsection 725-145(1) will not be present.

[1] All future legislative references are to the Income Tax Assessment Act 1936, unless otherwise stated.

[2] According to the Valuation Report, the Capitalisation of Profits method which is based on the profits (before interest and tax) generated by the business over the most recent relevant years, adjusted for non-commercial transactions. A business cap rate/profit multiple is then applied to this amount to determine the value of the business.

[3] The in-house asset rules for self-managed superannuation funds broadly limit the level of in-house assets to x% of the fund's total assets.

[4] being the market value of the share at the time of the buy-back if the buy-back did not occur and was never planned to occur.

[5] The meaning of the term 'non-share dividend' is provided in section 974-120 of the ITAA 1997 and broadly means a distribution made by a company to holder of non-share equity interests in relation to those interests.

[6] $50/50 = $1.

[7] Subsection 45B(1) of the ITAA 1936, as well as other provisions in section 45A, 45B and 45C, provide anti-avoidance rules for demergers situations. However, as the proposed scheme between Perron Investments and the Trust does not relate to a demerger, these provisions will not be considered further in this ruling.

[8] This paragraph sits under the Section 45B heading, but the test of 'more than incidental purpose' is the same test s applies in s177EA, and therefore this paragraph is equally applicable here.