Private ruling: Proposed share buy-back
Date of advice: 20 December 2016
Published: May 2017
Ruling period: Income year ended 30 June 20XX
Date scheme commenced: 1 July 20XX

Ruling: Q1: Will the Commissioner make a determination under subsection 45A(2) of the Income Tax Assessment Act 1936 (ITAA 1936) that section 45C of the ITAA 1936 applies in relation to the whole, or a part, of the capital benefit under the proposed Buy-back? | A1: No. | Q2: Will the Commissioner make a determination under subsection 45B(3) of the ITAA 1936 that section 45C of the ITAA 1936 applies in relation to the whole, or a part, of the capital benefit under the proposed Buy-back? | A2: No. | Q3: Will the Commissioner make a determination under subsection 204-30(3) of the Income Tax Assessment Act 1997 (ITAA 1997) in respect of the dividend component of the Buy-back? | A3: No. | Q4: Will the Commissioner make a determination under subsection 177EA(5) of the ITAA 1936 in respect of the dividend component of the Buy-back? | A4: No.

Relevant facts and circumstances: The Company is an Australian incorporated unlisted private company that is the head company of a tax consolidated group. The Company is controlled by less than five shareholders (Majority Shareholders). The remainder of the ordinary shareholders in the Company are a mix of entities (the Exiting Shareholders). All shareholders of the Company are Australian residents for income tax purposes. The Majority Shareholders have been involved in negotiations to sell the Company. A preferred buyer (Buyer) has been identified who has offered the Majority Shareholders a mix of cash and scrip to undertake the transaction. The Buyer wishes to capitalise on the expertise and experience of the Company to execute on engagements in Australia and retaining the Majority Shareholders is a key driver for the transaction. Accordingly, it is fundamental to the Buyer's bid that the Majority Shareholders remain in the business as both employees and equity holders in the business to help drive performance of the newly merged business. The Buyer does not want any shareholders, other than the Majority Shareholders, to retain any equity in the Company at the time of acquisition. To help facilitate the exit of the Exiting Shareholders, the Company proposes to buy-back (Buy-back) their ordinary shares at market value (the Buy-back price). A portion of the Buy-back price will be a return of capital (which has been calculated using the average capital per share (ACPS) methodology) and the remainder will be a dividend, franked to the maximum extent possible having regard to the franking account balance of the Company at the relevant time.

Relevant legislative provisions: 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 section 177EA | Income Tax Assessment Act 1997 section 204-30

Reasons for decision: Summary: The Commissioner will not make a determination under subsection 45A(2) of the Income Tax Assessment Act 1936 (ITAA 1936) that section 45C of the ITAA 1936 applies in relation to the whole, or a part, of the capital benefit under the proposed Buy-back. | Detailed Reasoning - Detailed Reasoning: Section 45A of the ITAA 1936 is an anti-avoidance provision that applies in circumstances where capital benefits are streamed to shareholders who derive a greater benefit from the receipt of the capital benefit (the advantaged shareholder) and it is reasonable to assume that the other shareholders have received or will receive dividends (the disadvantaged shareholders). Although a 'capital benefit' (as defined in paragraph 45A(3)(b) of the ITAA 1936) is provided to the Exiting Shareholders 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. Under the Buy-back, all Exiting Shareholders will receive both a distribution of share capital as well as a dividend component in equal proportion based on the number of shares they sold into the Buy-back. Accordingly, section 45A of the ITAA 1936 has no application to the Buy-back. Accordingly, the Commissioner will not make a determination under subsection 45A(2) of the ITAA 1936 that section 45C of the ITAA 1936 applies in relation to the whole, or a part, of the proposed off-market share Buy-back. | Summary: The Commissioner will not make a determination under subsection 45B(3) of the ITAA 1936 that section 45C of the ITAA 1936 applies in relation to the whole, or a part, of the capital benefit under the proposed Buy-back. | Detailed Reasoning - Detailed Reasoning: Section 45B of the ITAA 1936 applies where: ● 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), and ● under the scheme, a taxpayer (the relevant 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 ● 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 (paragraph 45B(2)(c) of the ITAA 1936). Scheme A 'scheme' for the purposes of section 45B of the ITAA 1936 has the meaning given by subsection 995-1(1) of the ITAA 1997 (see subsection 45B(10) of the ITAA 1936). That definition is widely drawn and includes any arrangement, scheme, plan, proposal, action, course of action or course of conduct, whether unilateral or otherwise. The Company's proposed off-market share Buy-back would be captured within this broad definition. Capital Benefit The phrase 'provided with a capital benefit' is defined in subsection 45B(5) of the ITAA 1936. A person is provided with a capital benefit if: (a) an ownership interest in a company is issued to the person (b) there is a distribution to the person of share capital or share premium, or (c) the company does something in relation to an ownership interest that has the effect of increasing the value of the ownership interest (which may or may not be the same interest) held by that person. On the basis that part of the Buy-back price comprises a return of share capital to the shareholders, there will be the provision of a capital benefit within the meaning of paragraph 45B(5)(b) of the ITAA 1936). Tax Benefit A relevant taxpayer 'obtains a tax benefit' as defined in subsection 45B(9) of the ITAA 1936 if: ● the amount of tax payable; or ● any other amount payable under the ITAA 1936 or the ITAA 1997, would, apart from the operation of section 45B, be less than the amount that: ● would have been payable; or ● be payable at a later time than it would have been payable, if the capital benefit had instead been a dividend. 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 Exiting Shareholders will generally obtain tax benefits from the proposed off-market share Buy-back. Relevant Circumstances While the conditions of paragraphs 45B(2)(a) and (b) of the ITAA 1936 are met in respect of the Buy-back, having regard to the 'relevant circumstances' (as set out in subsection 45B(8) of the ITAA 1936), the requisite purpose of enabling a person to obtain a tax benefit as a result of the capital distribution was not present, in particular: ● the distribution of share capital accords with the ACPS method and could not be said to be attributable to the profits of the Company; ● the pattern of distribution of the Company does not indicate that the distribution of share capital reflects amounts in substitution for a dividend; and ● The distribution of share capital will be made equally to all Exiting Shareholders on the basis of their proportionate interest in the shares, irrespective of their particular tax profile. ● as a consequence of the Buy-back, the distribution of share capital will result in the cancellation of shares in the Company held by Exiting Shareholders and a corresponding loss of dividend, voting and other rights. Therefore, 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 any part of the distribution of share capital as an unfranked dividend paid by the Company. | Summary: The Commissioner will not make a determination under subsection 204-30(3) of the ITAA 1997 in respect of the dividend component of the Buy-back. | Detailed Reasoning - Detailed Reasoning: Subdivision 204-D of the ITAA 1997 contains provisions which aim to prevent the streaming of franking credits to one member of a corporate tax entity in preference to another. Section 204-30 of the ITAA 1997 applies where an entity streams one or more distributions in such a way that the franking credits attaching to the distribution are received by those members of the entity who derive a greater benefit from them (favoured member); and other members receive lesser imputation or no imputation benefits (disadvantaged member). If section 204-30 of the ITAA 1997 applies, the Commissioner is vested with a discretion under subsection 204-30(3) of the ITAA 1997 to make a determination in writing: (a) that a specified franking debit arises in the franking account of the entity, for a specified distribution or other benefit to a disadvantaged member (paragraph 204-30(3)(a) of the ITAA 1997), and/or (b) that no imputation benefit is to arise in respect of any streamed distribution made to a favoured member and specified in the determination (paragraph 204-30(3)(c) of the ITAA 1997). For this section to apply, members to whom distributions are streamed must be in a position to derive a greater benefit from the franking credits than other members. Subsection 204-30(8) of the ITAA 1997 details examples of when a member of an entity will be taken to have derived a greater benefit from franking credits than another member. These are where the other member: (a) is not an Australian resident; (b) is not entitled to use the tax offset under Division 207; (c) incurs a tax liability as a result of the distribution that is less than the benefit associated with the tax offset attributable to the distributions; (d) is a corporate tax entity at the time the distribution is made, but no franking credit arises for the entity as a result of the distribution; (e) is a corporate tax entity at the time the distribution is made, but cannot use the franking credits to frank a distribution to its own members because it is not a franking entity or is unable to make a frankable distribution; and (f) is an exempting entity. In the current circumstances, the shareholders in the Company are of various types and with various tax characteristics. It is therefore likely that a member will derive a greater benefit from franking credits attached to the Buy-back price than another member. As a result, the conditions in subsection 204-30(1) of the ITAA 1997 are met. However, the Commissioner will not make a determination under subsection 204-30(3) of the ITAA 1997 in respect of the dividend component of the Buy-back. | Summary: The Commissioner will not make a determination under subsection 177EA(5) of the ITAA 1936 in respect of the dividend component of the Buy-back. | Detailed Reasoning - Detailed Reasoning: Section 177EA of the ITAA 1936 is a general anti avoidance provision that applies where one of the purposes (other than an incidental purpose) of the scheme is to obtain an imputation benefit. Where section 177EA of the ITAA 1936 applies, the Commissioner has a discretion, pursuant to subsection 177EA(5) of the ITAA 1936, to make a determination to debit the company's franking account pursuant to paragraph 177EA(5)(a) of the ITAA 1936, or deny the imputation benefit to each shareholder pursuant to paragraph 177EA(5)(b) of the ITAA 1936. Specifically, section 177EA of the ITAA 1936 applies if the following conditions, set-out in subsection 177EA(3) of the ITAA 1936 are satisfied: (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. It is considered that the conditions in paragraphs 177EA(3)(a) to 177EA(3)(d) of the ITAA 1936 are satisfied in respect of the proposed Buy-back because: (f) the Buy-back constitutes a scheme for the disposition of a membership interest (paragraph 177EA(3)(a) of the ITAA 1936). Pursuant to paragraph 177EA(14)(b) of the ITAA 1936, a 'scheme for a disposition of membership interests or an interest in membership interests' includes a scheme that involves entering into an arrangement or transaction that changes or otherwise affects the legal or equitable ownership of the membership interests. (g) frankable distributions are expected to be paid to the Exiting Shareholders for their shares (paragraph 177EA(3)(b) of the ITAA 1936) because the Buy-back price will include a franked dividend. (h) franked distributions are expected to be paid to the Exiting Shareholders (paragraph 177EA(3)(c) of the ITAA 1936). and (i) it is reasonable to expect that an imputation benefit will be received by the relevant taxpayers as a result of distributions made to the Exiting Shareholders given that Company expects to frank the distributions: paragraph 177EA(3)(d) of the ITAA 1936. As the threshold requirements of section 177EA of the ITAA 1936 have been met, it is necessary to consider the 'relevant circumstances' of the scheme in determining whether it could 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 the purpose (whether or not the dominant purpose but not including an incidental purpose) of enabling the relevant taxpayer to obtain an imputation benefit. In arriving at a conclusion the Commissioner must have regard to the relevant circumstances of the scheme which include, but are not limited to, the circumstances set out in subsection 177EA(17) of the ITAA 1936. The relevant circumstances encompass a range of circumstances which, taken individually or collectively, could indicate the requisite purpose. Due to the diverse nature of these circumstances, some may not be present at any one time in any one scheme. From consideration of the factors contained in subsection 177EA(17) of the ITAA 1936, the Commissioner has come to the view that subsection 177EA(5) of the ITAA 1936 does not apply in relation to the proposed Buy-back. Accordingly, the Commissioner will not make a determination under subsection 177EA(5) of the ITAA 1936.