Private ruling: Share Buy Back
Date of advice: 15 December 2015
Published: February 2016
Ruling period: Year of income ended 30 June 2016 | Year of income ended 30 June 2017 | Year of income ended 30 June 2018 | Year of income ended 30 June 2019 | Year of income ended 30 June 2020
Date scheme commenced: 1 July 2015

Ruling: Question and Answer | Will the Commissioner make a determination pursuant to section 45B of the ITAA 1936 that section 45C of the ITAA 1936 applies to the proposed share buy back? | No

Relevant facts and circumstances: The Company is a private company incorporated in 200X. The Company has X fully paid shares on issue. The Company has X shareholders, a mixture of individual and non-individual entities. X of the shareholders are not residents of Australia for tax purposes. The Company developed, built and currently operates a farm project with an operational/technical design life of X years. The Company supplies utilities. During the planning and construction phase of the project, no commercial loans were available, as the concept of a community sized, privately owned farm was novel. In order to undertake the project it was necessary to raise all the required capital from the shareholders with the specific purposes of purchasing the related equipment. The project has a finite life (the X year operational design life). The scrap value at the end of the operational period is anticipated to be sufficient to dismantle the plant and remediate the leasehold property on which it stands, leaving no residual capital in the Company. The project contract (and thus the future income) is fixed in its rate and limited by the system's capacity, hence defining the entity's profitability and eliminating any growth capacity. The Company has no franking credits and has tax losses forecast to be used by the 2020 financial year. In 20XX the Company obtained a commercial loan. Share buyback As the company is not listed the buyback will be an off-market buy back. Subject to sales of power which varies within a X% band due to the nature of the local resources to instigate the following share buybacks; XX% of the shares in each financial year beginning in the relevant financial year and ending in the 2020-21 financial year. This will mean by 2021 approximately XX% of the shares would have been bought back and retired. The value of the shares is determined on the basis of expected returns of the remaining life of the project. The capital distributions will be made equally to all shareholders on the basis of their proportionate interest in the Company, irrespective of their particular tax profile. It is not expected that any of the relevant taxpayers will have capital losses at the time of the transactions.

Relevant legislative provisions: Income Tax Assessment Act 1936 Section 45B | Income Tax Assessment Act 1936 Subsection 45B(1) | Income Tax Assessment Act 1936 Subsection 45B(2) | Income Tax Assessment Act 1936 Paragraph 45B(2)(c) | Income Tax Assessment Act 1936 Subsection 45B(3) | Income Tax Assessment Act 1936 Paragraph 45B(3)(a) | Income Tax Assessment Act 1936 Subsection 45B(4) | Income Tax Assessment Act 1936 Subsection 45B(8) | Income Tax Assessment Act 1936 Paragraph 45B(8)(a) | Income Tax Assessment Act 1936 Paragraph 45B(8)(b) | Income Tax Assessment Act 1936 Paragraph 45B(8)(c) | Income Tax Assessment Act 1936 Paragraph 45B(8)(d) | Income Tax Assessment Act 1936 Paragraph 45B(8)(e) | Income Tax Assessment Act 1936 Paragraph 45B(8)(f) | Income Tax Assessment Act 1936 Paragraph 45B(8)(g) | Income Tax Assessment Act 1936 Paragraph 45B(8)(h) | Income Tax Assessment Act 1936 Paragraph 45B(8)(i) | Income Tax Assessment Act 1936 Paragraph 45B(8)(j) | Income Tax Assessment Act 1936 Paragraph 45B(8)(k) | Income Tax Assessment Act 1936 Subsection 45B(9) | Income Tax Assessment Act 1936 Section 45BA | Income Tax Assessment Act 1936 Section 45C | Income Tax Assessment Act 1936 Subsection 177A(1) | Income Tax Assessment Act 1936 Paragraph 177D(2)(a) | Income Tax Assessment Act 1936 Paragraph 177D(2)(b) | Income Tax Assessment Act 1936 Paragraph 177D(2)(c) | Income Tax Assessment Act 1936 Paragraph 177D(2)(d) | Income Tax Assessment Act 1936 Paragraph 177D(2)(e) | Income Tax Assessment Act 1936 Paragraph 177D(2)(f) | Income Tax Assessment Act 1936 Paragraph 177D(2)(g) | Income Tax Assessment Act 1936 Paragraph 177D(2)(h)

Reasons for decision: Summary: Section 45B of the ITAA 1936 applies where certain capital payments, including a return of capital, are paid to shareholders in substitution for dividends. The purpose of section 45B of the ITAA 1936 is to ensure that relevant amounts distributed to shareholders of a company are treated as dividends for tax purposes if certain payments, allocations and distributions are made in substitution for dividends. The conditions that must be met in order for section 45B of the ITAA 1936 to apply are set out in subsection 45B(2) of the ITAA 1936: This section applies if: (a) there is a scheme under which a person is provided with a demerger benefit or a capital benefit by a company; and (b) under the scheme, a taxpayer (the relevant taxpayer ), who may or may not be the person provided with the demerger benefit or the capital benefit, obtains a tax benefit; and (c) having regard to the relevant circumstances of the scheme, it would be concluded that the person, or one of the persons, who entered into or carried out the scheme or any part of the scheme did so for a purpose (whether or not the dominant purpose but not including an incidental purpose) of enabling a taxpayer ( the relevant taxpayer ) to obtain a tax benefit. Where the requirements of subsection 45B(2) of the ITAA 1936 are met, subsection 45B(3) of the ITAA 1936 empowers the Commissioner to make a determination under section 45C of the ITAA 1936 in relation to a capital benefit. The effect of a determination made under paragraph 45B(3)(b) of the ITAA 1936 is that part, or all of a capital benefit, will be treated as not being a dividend (subsection 45C of the ITAA 1936). Each of the key terms referred to in subsection 45B(2) of the ITAA 1936 is considered below. Scheme A 'scheme' for the purposes of section 45B of the ITAA 1936 is taken to have the same meaning as provided in subsection 177A(1) of the ITAA 1936. That definition is widely drawn and includes any agreement, arrangement, understanding, promise, undertaking, scheme, plan, or proposal. In particular, a scheme is anything that satisfies any of the terms in the statutory definition. The phrase 'provided with a capital benefit' is defined in subsection 45B(5) of the ITAA 1936. It includes the distribution to a person of share capital. In the present circumstances, it is considered that the share buy-back constitutes the relevant scheme for the purposes of section 45B of the ITAA 1936. Capital benefit For the purposes of section 45B of the ITAA 1936, a person is provided with a capital benefit (as defined in subsection 45B(5) of the ITAA 1936) by reference to any of the following: (a) the provision of ownership interests in a company to the person; or (b) the distribution to the person of share capital or share premium; (c) something that is done in relation to an ownership interest that has the effect of increasing the value of an ownership interest (which may or may not be the same interest) that is held by the person. On the basis that the buy-back price comprises a return of share capital to the shareholders, there is a provision of a capital benefit within the meaning of paragraph 45B(5)(b) of the ITAA 1936). Tax benefit Subsection 45B(9) of the ITAA 1936 provides that a taxpayer 'obtains a tax benefit' if the amount of tax payable by the relevant taxpayer (not necessarily the same person receiving the capital benefit (refer paragraph 45B(2)(b) of the ITAA 1936) would, apart from section 45B of the ITAA 1936, 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 a dividend. The definition is very broad and unlike the definition of a tax benefit in Part IVA, subsection 45B(9) of the ITAA 1936 does not require a consideration of what would have occurred but for the scheme. Rather, the relevant approach under subsection 45B(9) of the ITAA 1936 appears to be to determine (on a stand-alone basis) whether there is a tax benefit compared to the tax consequences that would arise if the capital benefit were a dividend. It should be noted that ordinarily, a return of capital would be subject to the CGT provisions of the Income Tax law. Unless the amount of the distribution exceeds the cost base of the shares, there will only be a cost base reduction under CGT event G1 (section 104-135 of the ITAA 1997). It is only to the extent (if any) that the distribution exceeds the cost base of the shares that a capital gain arises. By contrast a dividend would generally be included in the assessable income of a resident shareholder or in the case of a non-resident, be subject to dividend withholding tax. Therefore, the Company's shareholders will generally obtain tax benefits from the proposed Capital Return. Relevant circumstances Given that the proposed share buy-back is a scheme that provides a tax benefit to the shareholders, the operation of section 45B of the ITAA 1936 turns on the objective purpose test in paragraph 45B(2)(c) of the ITAA 1936. 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. Paragraph 45B(2) of the ITAA 1936 requires the Commissioner to consider the 'relevant circumstances' of the scheme as set out in subsection 45B(8) of the ITAA 1936. PS LA 2008/10 Application of section 45B of the Income Tax Assessment Act 1936 to share capital reductions provides specific guidance to tax officers regarding the application of this subsection. 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 (an ordinary shareholder of the 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. Paragraph 45B(8)(a) Appropriate capital and profit allocation The factor in paragraph 45B(8)(a) is: the extent to which the capital benefit is attributable to capital or the extent to which the capital benefit is attributable to profits (realised and unrealised) of the company or an associate; The Company intends to allocate the whole amount of the capital benefit to its share capital account Paragraph 45B(8)(b) Pattern of distributions Paragraph 59 of PS LA 2005/21 states, in part, that: When a company accumulates all its profits, a subsequent distribution of profit, if it occurs, is more likely to occur as a single, extraordinary payment. It may in such cases be tempting to seek to secure a tax-effective mode of distribution. There is credible evidence of a 'no dividend policy' having been adopted by the Company. Over the last six years the Company has established a regular pattern of payment of dividends to its shareholders. In explaining the over-arching purpose of paragraphs 45B(8)(c) to 45B(8)(f), paragraph 60 of PS LA 2005/21 states that: Paragraphs 45B(8)(c) to (f) of the ITAA 1936 require that consideration be given to the tax characteristics of the owners of the head entity and thus to determining the tax effects of the scheme. If the tax characteristics of the owners of the head entity are such as to indicate there is a tax preference for one form of distribution (capital or profit) over another, this may be suggestive of a more than incidental purpose of delivering a tax benefit, particularly if the composition of the distribution does not follow the substance of what was provided. Paragraph 45B(8)(c) Capital losses It is not expected that the relevant taxpayers have capital losses at the time of the transactions. Paragraph 45B(8)(d) Pre CGT ownership interests The Company was incorporated after 19 September 1985. Paragraph 45B(8)(e) Residency The shareholders participating in the share buy-back will be a mix of companies and individuals, residents and non-residents. Of the XX shareholders, X individuals are non-residents for income tax purposes. The capital distribution will be made equally to all participating shareholders on the basis of their proportionate interest in the shares, irrespective of their particular tax profile. Paragraph 45B(8)(f) Cost base of ownership interests The total shareholder cost base of the shares immediately before the share buy-back event was $X. Paragraph 45B(8)(g) repealed Paragraph 45B(8)(h) Nature of interest after the distribution The factor specified in paragraph 45B(8)(h) of the ITAA 1936 is: 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; This factor is aimed at discerning whether a distribution is a genuine return of capital. If the interest held by the relevant taxpayer after the distribution remains the same as if a dividend had been paid instead, this would not be suggestive of a genuine return of capital. However, if, the proportionate voting and other interests held by the taxpayer are less than the taxpayer's interests before the distribution, this would suggest a genuine return of capital. In the present case, the share buy-back will result in a reduction of the shareholders ownership interests in the shares which is consistent with a genuine return of capital. In this regard, it is noted that the Company Law Review EM, which introduced the former section 45B, stated that: [I]f the proportionate voting and other interests held by the taxpayer are less than the taxpayer's pre-reduction interest, this would suggest a genuine return of capital. The Explanatory Memorandum to the New Business Tax System (Consolidation, Value Shifting, Demergers and Other Measures) Act 2002 , which introduced the current section 45B, states that the current section is intended to replicate the integrity rule of the former section 45B with respect to capital benefits. Therefore, this is indicative of the share buy-back being a genuine return of capital. Paragraph 45B(8)(i) Provision of ownership interests and later disposal and Paragraph 45B(8)(j) Transactions between entity and associates The circumstances covered by paragraphs 45B (8)(i) and (j) of the ITAA 1936 pertaining to the provision of ownership interests or demergers are not relevant here. Paragraph 45B(8)(k) Part IVA matters Paragraph 45B(8)(k) of the ITAA 1936 includes also 'any of the matters referred to in paragraphs 177D(2)(a) to (h) of ITAA 1936'. The inclusion of the eight matters listed in subsection 177D(2) of the ITAA 1936 effectively widens the issues that the Commissioner may have regard to in determining the relevant purpose with which a particular scheme is entered into. In relation to the requirements of subsection 177D(2) of the ITAA 1936: (a) the share buy-back is being undertaken by the Company for the purpose of optimising its capital funding structure. (b) the form and substance of the share buy-back arrangement coincide, and (c) the share buy-back is an arm's length transaction between the Company and the participating shareholders. | Detailed Reasoning - Conclusion: Having regard to the relevant circumstances of the scheme set out in subsection 45B(8) of the ITAA 1936, it would not be concluded that any of the parties to the scheme entered into or carried out the scheme for more than an incidental purpose of obtaining a tax benefit in the form of a capital benefit. It follows that the tax benefit, is an outcome that occurs incidentally to the commercial purposes. Accordingly, the Commissioner will not make a determination under paragraph 45B(3)(a) of the ITAA 1936 that section 45BA of the ITAA 1936 applies to the 'capital benefit' provided under the proposed scheme.