Private ruling: Off market share buy-back and conduit foreign income
Date of advice: 1 August 2018
Published: September 2018
Ruling period: 1 July 2017 – 30 June 2018 | 1 July 2018 – 30 June 2019
Date scheme commenced: 1 July 2017

Ruling: Q1:  | A1: Yes | Q2:  | A2: Yes | Q3:  | A3: Yes | Q4:  | A4: Yes | Q5:  | A5: Yes | Q6:  | A6: No | Q7:  | A7: No | Q8:  | A8: No | Q9:  | A9: No

Relevant facts and circumstances: Background Company X is an Australian incorporated company. Its principal activity is to act as a holding company. Its shares are not listed on any stock exchange. Company W is a foreign incorporated company. It does not carry on business in Australia and does not directly hold any assets in Australia. Company X holds a majority of the voting rights in Company W. Company X is owned by xx shareholders, including Trust Z. Trust Z holds its shares in Company X on capital account. That is, the shares are not held as trading stock. The shares held by Trust Z in Company X were acquired after 20 September 1985. Central management and control of Trust Z is outside of Australia as the trustee, a foreign resident, has control of the decision making process of Trust Z in its capacity as the trustee. Given the trustee of Trust Z is a company incorporated outside of Australia and is a non-resident of Australia for tax purposes, and central management and control of the trustee is outside of Australia, Trust Z is a non-resident trust of Australia for tax purposes. Beneficiaries of Trust Z The beneficiaries of Trust Z are Beneficiary A and members of their family. Beneficiary A is currently not an Australian tax resident and will not be an Australian tax resident when the share buy-back occurs. Proposed share buy-back References to the ‘dividend component’ throughout this private ruling application are references to the dividend component of the proposed share buy-back. The following is proposed to take place: ● Company W will pay a distribution to Company X; ● Trust Z’s shares in Company X will be 100% bought back by Company X under a share buy-back arrangement for the buy-back price (market value of the shares to be bought back); ● Company X will use the abovementioned dividends from Company W to fund the proposed share buy-back; ● Payment of a portion of the buy-back price will be deferred for a nominated period from the date the buy-back occurs. The exiting shareholder is definitively entitled to the deferred amount at the date of the share buy-back. Therefore, the deferred amount is included in the buy-back price as the seller is entitled to receive this amount as a result of or in respect of the share buy-back (section 159GZZZM); and ● The dividend that will be distributed by Company W to Company X will be equivalent to or greater than the final agreed buy-back price of the proposed share buy-back. The buy-back price is equal to / does not exceed the market value of the shares. The market valuation complies with the ATO Market Valuation Guidelines Company X will use the average capital per share (ACPS) methodology to determine the value of the capital and dividend components of the proposed share buy-back. For each share bought back by Company X, Company X will debit an amount (capital component) to its share capital account and debit the balance of the buy-back price (dividend component) against retained earnings. The dividend component will be wholly unfranked. Company X will declare the entire dividend component to be conduit foreign income on or before the day on which the dividend is made, and this declaration will be made in a distribution statement issued to Trust Z. Beneficiary A will be made presently entitled to all of the income of Trust Z that is attributable to the dividend component of the proposed share buy-back.

Relevant legislative provisions: Income Tax Assessment Act 1936 section 6-1 | Income Tax Assessment Act 1936 s ection 45A | Income Tax Assessment Act 1936 s ection 45B | Income Tax Assessment Act 1936 section 45C | Income Tax Assessment Act 1936 section 177EA | Income Tax Assessment Act 1936 section 159GZZZK | Income Tax Assessment Act 1936 paragraph 159GZZZK(a) | Income Tax Assessment Act 1936 paragraph 159GZZZK(b) | Income Tax Assessment Act 1936 paragraph 159GZZZK(d) | Income Tax Assessment Act 1936 section 159GZZZM | Income Tax Assessment Act 1936 paragraph 159ZZZM(a) | Income Tax Assessment Act 1936 section 159GZZZP | Income Tax Assessment Act 1936 subsection 159GZZZP(1) | Income Tax Assessment Act 1936 section 159GZZZQ | Income Tax Assessment Act 1936 paragraph 350(1)(a) | Income Tax Assessment Act 1997 s ection 202-45 | Income Tax Assessment Act 1997 s ection 204-26 | Income Tax Assessment Act 1997 s ection 204-30 | Income Tax Assessment Act 1997 Division 725 | Income Tax Assessment Act 1997 Division 727 | Income Tax Assessment Act 1997 s ection 768-5 | Income Tax Assessment Act 1997 section 768-10 | Income Tax Assessment Act 1997 section 768-15 | Income Tax Assessment Act 1997 s ection 802-15 | Income Tax Assessment Act 1997 s ection 802-20 | Income Tax Assessment Act 1997 subs ection 802-20(1) | Income Tax Assessment Act 1997 subs ection 802-20(2) | Income Tax Assessment Act 1997 s ection 802-30 | Income Tax Assessment Act 1997 section 960-115 | Income Tax Assessment Act 1997 sub section 960-120(1) | Income Tax Assessment Act 1997 section 960-190 | Income Tax Assessment Act 1997 section 974-75 | Income Tax Assessment Act 1997 section 995-1

Reasons for decision: Summary: Summary The proposed dividend from Company W to Company X will be non-assessable non-exempt income of Company X as the criteria under Division 768-A of the ITAA 1997 will be satisfied. Detailed reasoning Under Subdivision 768-A of the ITAA 1997, where an Australian corporate tax entity receives a foreign equity distribution from a foreign company, either directly or indirectly through one or more interposed trusts or partnerships, and the Australian corporate tax entity holds a participation interest of at least 10% in the foreign company, the distribution is non-assessable non-exempt income for the Australian corporate tax entity. Subsection 768-5(1) states: A foreign equity distribution is not assessable income, and is not exempt income, of the entity to which it is made if: (a) the entity is an Australian resident and a corporate tax entity; and (b) at the time the distribution is made, the entity satisfies the participation test in section 768-15 in relation to the company that made the distribution; and (c) the entity: (i) does not receive the distribution in the capacity of a trustee; or (ii) receives the distribution in the capacity of a trustee of a public trading trust. Subsection 995-1(1) states that “Australian resident” means a person who is a resident of Australia for the purposes of the ITAA 1936. Subsection 6(1) of ITAA 1936 states that a resident of Australia includes a company which is incorporated in Australia. Section 960-115 states that an entity that is a company is a “corporate tax entity”. Section 768-10 defines a “foreign equity distribution” as: A * distribution or * non-share dividend made by a company that is a foreign resident in respect of an * equity interest in the company. Item 1 of the table in subsection 960-120(1) states that a “distribution” by a company is constituted by “a dividend, or something that is taken to be a dividend, under this Act.” Subsection 995-1(1) states that a “foreign resident” means a person who is not a resident of Australia for the purposes of ITAA 1936. Item 1 of subsection 974-75(1) states that “an interest in the company as a member or stockholder of the company” is an “equity interest”. Section 768-15 provides that an entity satisfies the participation test in relation to another entity where the sum of the following is at least 10%: (a) the direct participation interest the entity would have in the other entity if rights on winding-up were disregarded; (b) the indirect participation interest the entity would have in the other entity if: (i) rights on winding-up were disregarded; and (ii) section 960-185 only applied to intermediate entities that are not corporate tax entities. The definition of “direct participation interest” in a company in item 1 of subsection 960-190(1) directs to the definition of “direct control interest”, which per paragraph 350(1)(a) of ITAA 1936 includes the percentage of the total paid-up share capital of a company that an entity holds. Application to your circumstances Company X will receive dividends from Company W, a company not resident in Australia, in respect of Company X’s shareholding in Company W. The dividends paid to Company X will be a distribution, per subsection 960-120(1), made by a company that is a foreign resident, per subsection 995-1(1), in respect of Company X’s equity interest in the company, per subsection 974-75(1). As such, the dividends will be a foreign equity distribution. As an Australian registered company, Company X is an Australian resident, per subsection 995-1(1) of ITAA 1997 and subsection 6(1) of ITAA 1936. Company X is also a corporate tax entity per section 960-115 of ITAA 1997. Company X’s direct control interest in Company W, per paragraph 350(1)(a) of ITAA 1936, is and was at the time of the distributions a share greater than 10%. As such, Company X’s combined shareholding satisfies the participation test in section 768-15, as per TR 2017/3. Company X did not receive the distribution in the capacity of a trustee or in the capacity of a trustee of a public trading trust. As these conditions have been satisfied, the dividends paid to Company X by Company W are non-assessable non-exempt income under section 768-5(1). Summary The proposed dividend distribution from Company W to Company X will constitute conduit foreign income of Company X. Detailed reasoning Subdivision 802-A of the ITAA 1997 sets out the method of working out your Conduit Foreign Income. Your CFI includes the following amounts: (i) The ordinary or statutory income you derive, providing further that certain conditions, assumptions and adjustments are satisfied or made (subsections 802-30(1) and (2)) (ii) An unfranked part of a frankable distribution you receive directly from another Australian corporate tax entity, or indirectly through a trust or partnership, to the extent it is declared to be CFI (paragraphs 802-30(3)(a) and (3)(b)); and (iii) A foreign equity distribution you receive directly from a foreign resident company, or indirectly through a trust or partnership, that is not assessable, not exempt income pursuant to section 768-5 (paragraph 802-30(3)(c)) In your case, the dividend distribution is a foreign equity distribution received from a foreign resident company will be non-assessable non-exempt income in Australia and will be a frankable distribution. The dividend component will be wholly unfranked. Therefore the dividend distribution meets the criteria to be considered conduit foreign income in accordance with section 802-30 of the ITAA 1997. The declaration of CFI must be made on or before the day the company actually makes the proposed distribution. Under item c) of section 202-45 of the ITAA 1997, where the buy-back price exceeds what would be the market value of the shares at the time of the buy-back (if the buy-back did not take place and were never proposed to take place), the excess amount is unfrankable. Should the buy-back price exceed the market value of the shares the excess will be an unfrankable amount and cannot be declared CFI (section 802-15 of the ITAA 1997). Summary The proposed share buy-back will constitute an off-market purchase as defined under section 159GZZZK of the ITAA 1936. Detailed reasoning An 'off-market purchase' occurs when a company that is not listed on any official stock exchange buys a share in itself from a shareholder in the company (paragraph 159GZZZK(d)). When the off-market purchase occurs, it is a 'buy-back' and the shareholder is the seller (paragraphs 159GZZZK(a) and (b)). The purchase price for the purposes of the off-market buy-back provisions is defined in paragraph 159GZZZM(a) to include the amount of money that the seller has received or is entitled to receive as a result of or in respect of the buy-back. When a shareholder sells their shares to a company in an off-market buy-back, the tax consequences for the shareholder are set out in Subdivision C of Division 16K (sections 159GZZZP and 159GZZZQ of the ITAA 1936). Company X is proposing to buy-back the shares held by Trust Z. Company X’s shares are not listed for quotation in the official list of any stock exchange. Accordingly, for the purposes of Division 16K, the buy-back is an off-market purchase within the meaning given by paragraph 159GZZZK(d). Summary The ACPS is an appropriate method of determining the capital and dividend components of the share buy-back price. Detailed reasoning In an off-market buy-back of shares, section 159GZZZP applies to treat the difference between the purchase price and the part of the purchase price which is debited against the company's share capital account as a dividend. An essential aspect of any off-market share buy-back is the 'split' between the return of capital and dividend paid to participating shareholders. In Law Administration Practice Statement PS LA 2007/9 Share Buy-Backs , the ATO considers that there are a number of acceptable methodologies for ascertaining the capital/dividend split, although not all have equal applicability in every case. The preferred ATO methodology for determining the dividend/capital 'split' is the ACPS method unless companies can demonstrate exceptional circumstances for the use of an alternative methodology. The ACPS is obtained by dividing a company's ordinary issued capital by the number of shares on issue. The amount so derived is a reasonable estimate of any capital component of the split. The balance of any buy-back price would be a dividend. In the absence of any exceptional circumstances, we consider that the ACPS method that you have used is the most appropriate method and the split between the capital and dividend component has been calculated in accordance with this methodology. Summary The dividend component of the proposed share buy-back will be declared by Company X to be conduit foreign income and will therefore not be subject to dividend withholding tax. Detailed reasoning A distribution that an Australian corporate tax entity makes to a foreign resident is not subject to dividend withholding tax, and is not assessable income, to the extent that the entity declares it to be 'conduit foreign income'. Generally, conduit foreign income is foreign income which is derived by a foreign resident through an Australian entity (the conduit) which would not normally be assessable to that Australian entity. Subsection 802-15(1) of the ITAA 1997 provides that an unfranked distribution made by an Australian corporate tax entity that is declared in its distribution statement to be conduit foreign income: a) is not assessable income and is not exempt income of a foreign resident; and b) is an amount to which section 128B (liability to withholding tax) of the ITAA 1936 does not apply. Based on the above and for the following reasons, Company X will not be required to withhold any dividend withholding tax under section 128B of the ITAA 1936 from the dividend component: ● The dividend component will be a frankable distribution made by Company X, an Australian resident company; ● Company X will declare the dividend component to be CFI in its distribution statement, and the declaration will be made on or before the day on which the distribution is made; ● Company X will have sufficient CFI from the receipt of the dividend distribution from Company W from which it can declare the dividend component of the proposed share buy-back to be CFI; and ● Beneficiary A will be made presently entitled to 100% of the dividend component as a beneficiary of Trust Z. Summary Where Beneficiary A is made presently entitled to 100% of the share of the net income of Trust Z that is attributable to the dividend component of the proposed share buy-back, the trustee of Trust Z will not be assessed and will not be liable to pay tax under section 98, 99 and 99A in respect of the dividend component. Detailed reasoning Beneficiary A will be made presently entitled to 100% of the dividend component as a beneficiary of Trust Z. CFI distributed to an Individual via a Trust qualifies for the CFI exemption from Australian tax. As Trust Z is a discretionary trust and it is within the powers of the trustee to distribute the dividends received to Beneficiary A as a beneficiary, Division 802 of the ITAA 1997 allows for: (a) the trust to receive, as the total or a proportion of its net income, an unfranked distribution from Company X that has been declared as CFI; (b) Company X to make the CFI declaration on or before the day that the distribution is made; and (c) after receiving the CFI distribution, Trust Z to distribute income to Beneficiary who will be a presently entitled, non-resident beneficiary. The proposed distribution by Company X will form part of the net income of Trust Z and will be reasonably attributable to the unfranked (but frankable) dividend paid by Company X. The trustee of Trust Z will not be assessed under sections 98, 99 or 99A of the ITAA 1936 in accordance with subsection 802-17(3) of the ITAA 1997. Summary The Commissioner will not make a determination under subsection 45A(2) or subsection 45B(3) that section 45C applies to treat all or part of the Capital Component of the buy-back price as an unfranked dividend. 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 the buy-back is treated as an unfranked dividend. Section 45A of the ITAA 1936 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. Although a 'capital benefit' (as defined in paragraph 45A(3)(b) of the ITAA 1936) is provided under the buy-back, the circumstances of the buy-back indicate that there is no streaming of capital benefits to some shareholders and dividends to other shareholders. Accordingly, section 45A of the ITAA 1936 has no application to the buy-back. Section 45B of the ITAA 1936 applies where certain capital payments are paid to shareholders in substitution for dividends. In broad terms, section 45B applies where: (a) there is a scheme under which a person is provided with a capital benefit by a company (paragraph 45B(2)(a) of the ITAA 1936); (b) under the scheme, a taxpayer, who may or may not be the person provided with the capital benefit, obtains a tax benefit (paragraph 45B(2)(b) of the ITAA 1936); 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 to obtain a tax benefit (paragraph 45B(2)(c) of the ITAA 1936). In this case, the conditions of paragraphs 45B(2)(a) and 45B(2)(b) of the ITAA 1936 have been met as the buy-back constitutes a scheme where the shareholders are provided with a capital benefit which has a tax benefit. Consideration then turns to whether the requisite purpose of enabling the shareholder to obtain a tax benefit by way of capital distribution is present. According to PS LA 2007/9, to apply section 45B of the ITAA 1936 to a share buy-back requires objective evidence of a substantial tax purpose of substituting share capital for a part of the purchase price which would otherwise be a dividend. A non-exhaustive list of relevant circumstances are found in paragraphs 45B(8)(a) - 45B(8)(k) of the ITAA 1936. Further considerations are listed in paragraphs 177D(b)(i) - 177D(b)(viii) of the ITAA 1936. Consideration of relevant circumstances The Commissioner considers that neither Company X nor Trust Z entered into or carried out the buy-back for a more than incidental purpose of enabling a person to obtain a tax benefit, having regard to the 'relevant circumstances' as set out in subsection 45B(8) of the ITAA 1936. Accordingly, the Commissioner will not make a determination under subsection 45B(3) of the ITAA 1936 that section 45C of the ITAA 1936 applies to treat all or part of the capital component of the buy-back price as an unfranked dividend. Summary The Commissioner will not make a determination pursuant to section 177EA of the ITAA 1936 or section 204-30 of the ITAA 1997 with respect to the proposed share buy-back. Detailed reasoning Section 177EA of the ITAA 1936 is an anti-avoidance provision that applies to a wide range of schemes entered into to obtain a tax advantage in relation to imputation benefits. In essence, it applies to schemes for the disposition of shares or an interest in shares, where a franked distribution is paid or payable in respect of the shares or an interest in shares. This includes a share buy-back with a franked dividend component. As the dividend was not a franked distribution under subsection 177EA(3), section 177EA does not apply to the buy-back. Section 204-30 of the ITAA 1997 is a further anti-avoidance provision to ‘prevent the streaming of imputation benefits to one member of a corporate tax entity in preference to another by either imposing a franking debit or denying an imputation benefit where there is streaming’ as outlined under section 204-30 of the ITAA 1997. Given there are no imputation benefits provided under the proposed share buy-back, section 204-30 does not apply to the share buy-back. Summary The value shifting rules in Divisions 725 and 727 of the ITAA 1997 will not apply to the proposed share buy-back. Detailed reasoning PS LA 2007/9 states that there may be a direct value shift in the context of a share buy-back where the buy-back is part of a broader capital restructure and consideration should also be given to the existence of any direct value shift prior to the share buy-back. Conducting an off-market share buy-back at a discount or premium may give rise to direct value shifting consequences. An indirect value shift arises where there is a net shift of value from one entity to another as stated in subsection 727-5(1) of the ITAA 1997. The general premise involves a reduction in the value of equity or loan interests in one entity and a corresponding increase in the value of interests in another entity. PS LA 2007/9 states that there may be an indirect value shift in the context of a buy-back where the buy-back is part of a broader capital restructure and consideration should also be given to the existence of any direct value shift prior to the share buy-back. An indirect value shift may also occur as a consequence of a direct value shift from a share buy-back. Given the buy-back price is equal to the market value of the shares, the off-market share buy-back will not give rise to a direct or indirect value shift.

Subject: Off market share buy-back and conduit foreign income: Question 1 Will the proposed dividend distribution from Company W to Company X be non-assessable non-exempt income of Company X under Division 768-A of the Income Tax Assessment Act 1997 (ITAA 1997)? | Question 2 Will the proposed dividend distribution from Company W to Company X constitute conduit foreign income (CFI) of Company X in accordance with section 802-25 of ITAA 1997? | Question 3 Will the proposed share buy-back constitute an off-market purchase within the meaning of section 159GZZZK of the Income Tax Assessment Act 1936 (ITAA 1936)? | Question 4 Will the average capital per share (ACPS) methodology be an appropriate method of determining the capital and dividend components of the proposed share buy-back purchase price under section 159GZZZP of the ITAA 1936? | Question 5 Will the dividend component of the proposed share buy-back price be exempt from dividend withholding tax under section 128B if the dividend component is declared by Company X to be CFI in accordance with section 802-15 of the ITAA 1997 and section 802-17 of the ITAA 1997? | Question 6 If the trustee of Trust Z resolves, in accordance with the Trust Deed, to make Beneficiary A, a foreign beneficiary of Trust Z, presently entitled to 100% of the share of the net income of the trust that is attributable to the dividend component of the proposed share buy-back, will the trustee of Trust Z be assessed and liable to pay tax under sections 98, 99 or 99A of the ITAA 1936 in respect of the net income of the trust that is attributable to the dividend component? | Question 7 Will either section 45A or section 45B of the ITAA 1936 apply to the proposed share buy-back such that the Commissioner may make a determination that section 45C of the ITAA 1936 will apply to the proposed share buy-back? | Question 8 Will the Commissioner make a determination pursuant to section 177EA of the ITAA 1936 and section 204-30 of the ITAA 1997 in relation to the proposed share buy-back? | Question 9 Will the value shifting rules in Divisions 725 and 727 of the ITAA 1997 apply to the proposed share buy-back?