Private ruling: Off-market share buy back
Date of advice: 25 August 2022
Published: November 2022
Ruling period: Year ending 30 June 20XX
Date scheme commenced: 1 July 2021

Ruling: Q1: Will the portion of the Buy-Back Price exceeding the Capital Component which is debited to A Pty Ltd's share capital account be a dividend for the purposes of section 159GZZZP of the Income Tax Assessment Act 1936 (ITAA 1936) and a frankable distribution for the purposes of section 202-40 of the Income Tax Assessment Act 1997 (ITAA 1997)? | A1: Yes. | Q2: Is the market value methodology adopted and applied by A Pty Ltd in determining the market value of its shares (i.e., the Reference Price under the Buy-Back scheme) appropriate for the purposes of applying paragraph 202-45(c) of the ITAA 1997 and section 159GZZZQ of the ITAA 1936, such that subsection 159GZZZQ will not apply to deem the Reference Price to be a higher amount? | A2: Yes. | Q3: Will the Commissioner make a determination under subsections 45B(3) and 45C(3) of the ITAA 1936, that a franking debit applies to the Capital Component of the Buy-Back. | A3: No. | Q4: Will the Commissioner make a determination under paragraph 204-30(3)(a) of the ITAA 1997 to debit A Pty Ltd's franking account? | A4: No. | Q5: Will the Commissioner make a determination under paragraph 177EA(5)(a) of the ITAA 1936 to debit A Pty Ltd's franking account? | A5: Yes.

Relevant facts and circumstances: 1. A Pty Ltd is a private, unlisted company incorporated in Australia and has been the head of an Australian consolidated group since XX/XX/20XX (A Pty Ltd Consolidated Group). 2. The A Pty Ltd Consolidated Group comprises: (a) A Pty Ltd, as the head company of the consolidated group, and (b) the members of the consolidated group, being B Pty Ltd; C Pty Ltd; D Pty Ltd, E Pty Ltd, F Pty Ltd, G Pty Ltd and H Pty Ltd. 3. The A Pty Ltd Consolidated Group's objective is to generate long-term investment returns by investing in a widely diversified portfolio across a range of asset classes and geographies. 4. As at XX/XX/XX, the post-tax Net Asset Value (NAV) of A Pty Ltd was $X, or $Y per share. During the financial year ended 30 June 20XX, A Pty Ltd revised its investment strategy, resulting in a substantial sell down of A Pty Ltd's listed Australian equities portfolio. As at 30 June 20XX, the fair value of listed investments totalled $XX and the fair value of unlisted investments (including investment properties) was $XXX. 5. As at 31 December 20XX, A Pty Ltd had a number of registered shareholders and a total of xxx issued ordinary shares. All A Pty Ltd shares are of one class. 6. As at 31 December 20XX, the beneficial shareholders of A Pty Ltd fall within the following categories in the percentages as set out below: Australian resident individuals xx% Australian resident companies xx% Australian resident trust estates/superannuation funds xx% Australian resident charities xx% Non-Australian resident individuals/trusts xx% 7. Prior to 20XX, A Pty Ltd's dividend policy provided for: (a) a core dividend of $0.XX per share per annum to be payable in two equal instalments (b) the declaration of a supplementary dividend (if any) as part of the final dividend that allowed shareholders to participate in the benefits of strong performance while protecting the NAV of A Pty Ltd in real terms, and (c) the declaration of supplementary dividends having regard to the franking account balance. 8. In 20XX, Pty Ltd revised its investment strategy and dividend policy. A Pty Ltd has stated that the new dividend policy adopted in 20XX is designed to support the compounding of portfolio gains and growth in NAV, delivering less frequent, but larger, distributions. Under the new policy, it is expected that a dividend will be declared at least every four years. The quantum of the dividend will be informed by the investment performance of A Pty Ltd over the four year period, while protecting the NAV of A Pty Ltd in real terms and A Pty Ltd's franking account balance. 9. The new policy provides scope for the Board of A Pty Ltd to determine if more frequent dividends may be appropriate. The terms of A Pty Ltd's new dividend policy reflect the anticipation that dividends will be fully franked for the foreseeable future and the intention that dividends will continue to be paid into the future on a sustainable basis. 10. A Pty Ltd has stated that as part of its transition to the new investment strategy and dividend policy, it declared and paid two fully franked special dividends in 20XX. 11. A Pty Ltd has also stated that liquidity in its shares remains a focus for the Board and its shareholders. In previous years, the off-market share buy-back was viewed by shareholders as one means by which liquidity is provided in A Pty Ltd shares. This will continue with future buy-backs. Current A Pty Ltd Off-Market Buy-Back Scheme 12. As part of A Pty Ltd's capital management strategy and to provide an opportunity to shareholders to sell some or all of their A Pty Ltd shares, A Pty Ltd proposes to refresh its x year buy-back programme where up to $XX of its shares would be bought back from its shareholders annually (Buy-Back). The Buy-Back programme is expected to commence during 20XX. 13. The Buy-Back invitation will only be made to shareholders of A Pty Ltd who are Australian residents. Any person who is (or who is acting on behalf of or for the account of a person who is) not in Australia is not eligible to participate in the Buy-Back. 14. For each round of Buy-Back (estimated to be X rounds in the next X years), a market value (referred to as the Reference Price under the Buy-Back scheme) will be determined for each A Pty Ltd share. This is derived by ascertaining the value of the latest NAV per A Pty Ltd share less any unpaid dividend per share to which the selling shareholder remains entitled notwithstanding the Buy-Back, less X% discount for the restrictions in the marketability of the shares. 15. The relevant NAV for a particular Buy-Back, will be determined using the calculation methodology as detailed in the File Note on NAV Determination which will be applied. 16. Any shares bought back by A Pty Ltd will be bought back at the Reference Price minus the discount percentage accepted by the Board (referred to as Buy-Back Price under the Buy-Back scheme). The Buy-Back Price will be determined after the tender process period has expired and will be less (depending on the buy-back discount selected by A Pty Ltd) or equal to the market value established. In no event will the Buy-Back Price per share be more than the Reference Price, as the Board does not propose to Buy-Back shares for more than their market value (or Reference Price). 17. The Board of A Pty Ltd will invite shareholders to offer some or all of their shares to A Pty Ltd by choosing a nominated discount percentage from the market value (or Reference Price). 18. A Pty Ltd will be conducting the Buy-Back through a tender process. A tender process will be run with the nominated various discount percentages. Alternatively, shareholders may choose to offer their shares as a 'final price tender', meaning that they agree to accept whatever discount is arrived at following the nominated percentages of other shareholders' tenders. The maximum discount will be X% to the Reference Price. 19. A Pty Ltd will not buy-back in excess of $XM if participating shareholders tender shares at a tender discount of X% or less. Eligible shareholders can tender different parcels of shares at different tender discount. 20. Generally, the tender period will remain open for a period of between X days and Y days and offers may be tendered at any time within that period. However, A Pty Ltd will make no decision to accept any offer until the tender period has expired, and the extent of its acceptances, if any, will depend upon the terms of the offers tendered. 21. Shareholders who tender their shares at a discount which is smaller than that accepted by the Board will have none of those shares bought back. Shareholders who tender their shares at a discount which is greater than that accepted by the Board will benefit from selling at a lower-than -tendered discount. 22. If necessary, as a result of tenders exceeding $XM of aggregate buy-back consideration, an equitable scale-back will be applied, proportionate to the number of shares tendered by each participating shareholder. 23. The Buy-Back Price will be debited to A Pty Ltd's share capital account proportionate to the ordinary issued capital per share based on the latest financial statements of A Pty Ltd, described as the 'Capital Portion'. The balance of the Buy-Back Price will be debited against retained profits, described as the 'Dividend Portion.' 24. The bought back shares will be cancelled by A Pty Ltd and the cash consideration will be remitted to shareholders. Assumption 25. A Pty Ltd is a resident of Australia under the income tax laws of Australia and not a resident of any other jurisdiction. 26. In accordance with A Pty Ltd's policy of fully franking its distributions, the franking percentage on the Dividend Component of the Buy-Back Price will be equal to the maximum franking credit as set out in section 202-60 of the ITAA 1997. 27. A Pty Ltd will frank the dividend component of the Buy-Back Price at the same franking percentage set as the benchmark for the franking period in which the Buy-Back Price will be paid. 28. The share capital account of A Pty Ltd is not 'tainted' within the meaning of section 197-50 of the ITAA 1997.

Relevant legislative provisions: Income Tax Assessment Act 1936 Section 45B | Income Tax Assessment Act 1936 Subsection 45B(3) | Income Tax Assessment Act 1936 Subsection 45B(8) | Income Tax Assessment Act 1936 Section 45C | Income Tax Assessment Act 1936 Subsection 45C(3) | Income Tax Assessment Act 1936 Section 159GZZZP | Income Tax Assessment Act 1936 Section 159GZZZQ | Income Tax Assessment Act 1936 Subsection 159GZZZQ(1) | Income Tax Assessment Act 1936 Subsection 159GZZZQ(3) | Income Tax Assessment Act 1936 Subsection 159GZZZQ(4) | Income Tax Assessment Act 1936 Section 177EA | Income Tax Assessment Act 1936 Subsection 177EA(3) | Income Tax Assessment Act 1936 Paragraph 177EA(3)(a) | Income Tax Assessment Act 1936 Subparagraph 177EA(3)(b)(i) | Income Tax Assessment Act 1936 Paragraph 177EA(3)(c) | Income Tax Assessment Act 1936 Paragraph 177EA(3)(d) | Income Tax Assessment Act 1936 Paragraph 177EA(3)(e) | Income Tax Assessment Act 1936 Paragraph 177EA(5)(a) | Income Tax Assessment Act 1936 Paragraph 177EA(14)(b) | Income Tax Assessment Act 1936 Subsection 177EA(17) | Income Tax Assessment Act 1936 Paragraph 177EA(17)(b) | Income Tax Assessment Act 1936 Paragraph 177EA(17)(c) | Income Tax Assessment Act 1936 Paragraph 177EA(17)(d) | Income Tax Assessment Act 1936 Paragraph 177EA(17)(g) | Income Tax Assessment Act 1936 Paragraph 177EA(17)(j) | Income Tax Assessment Act 1936 Subsection 177EA(18) | Income Tax Assessment Act 1936 Subsection 177EA(19) | Income Tax Assessment Act 1997 Section 197-50 | Income Tax Assessment Act 1997 Section 202-40 | Income Tax Assessment Act 1997 Section 202-60 | Income Tax Assessment Act 1997 Section 202-45 | Income Tax Assessment Act 1997 Subsection 202-45(c) | Income Tax Assessment Act 1997 Section 202-60 | Income Tax Assessment Act 1997 Section 204-30 | Income Tax Assessment Act 1997 Paragraph 204-30(1)(a) | Income Tax Assessment Act 1997 Paragraph 204-30(1)(b) | Income Tax Assessment Act 1997 Paragraph 204-30(1)(c) | Income Tax Assessment Act 1997 Subsection 204-30(3) | Income Tax Assessment Act 1997 Paragraph 204-30(3)(a) | Income Tax Assessment Act 1997 Subsection 204-30(1) | Income Tax Assessment Act 1997 Subsection 204-30(8) | Income Tax Assessment Act 1997 Paragraph 204-30(8)(a) | Income Tax Assessment Act 1997 Subsection 204-30(9) | Income Tax Assessment Act 1997 Subsection 204-30(10)

Reasons for decision: Detailed Reasoning - Question 1: Will the portion of the Buy-Back Price exceeding the Capital Component which is debited to A Pty Ltd's share capital account be a dividend for the purposes of section 159GZZZP of the ITAA 1936 and a frankable distribution for the purposes of section 202-40 of the ITAA 1997? | Summary: The Buy-Back Price exceeding the Capital Component that is debited to A Pty Ltd's share capital account, will be a dividend that is frankable under section 202-40 of the ITAA 1997. | Detailed Reasoning - Detailed reasoning: 1. Section 159GZZZP of the ITAA 1936 provides that where the buy-back of a share is an off-market purchase, the difference between purchase price and the part (if any) of the purchase price which is debited against the share capital account, is taken to be a dividend paid by the company to the seller on the day the buy-back occurs. 2. Subsection 202-40(1) of the ITAA 1997 states: A *distribution is a frankable distribution , to the extent that it is not unfrankable under section 202-45. 3. Paragraph 202-45(c) of the ITAA 1997 provides that the Dividend Component is frankable, but only to the extent that the Buy-Back price does not exceed the market value of the share at the time of the Buy-Back, if the Buy-Back did not occur and was never proposed to occur. 4. Under the A Pty Ltd Buy-Back scheme, the capital and dividend components of the Buy-Back price, will be worked out by applying the average capital per share (ACPS) methodology. The Capital Component of the Buy-Back price will be calculated by dividing A Pty Ltd's ordinary issued capital by the number of shares on issue, right before the tender period of each round of the Buy-Back. The Dividend Component of the Buy-Back price is calculated as the difference between the Buy-Back price and the Capital Component of the Buy-Back price. 5. The Capital Component of the Buy-Back, will be debited against amounts standing to the credit of A Pty Ltd's share capital account. Accordingly, the difference between the Buy-Back Price and the Capital Component, will be treated for the purposes of subsection 159GZZZP(1) of the ITAA 1936 as a dividend paid by A Pty Ltd out of the profits of A Pty Ltd on the day the Buy-Back occurs. 6. Paragraph 202-45(c) of the ITAA 1997 will not apply to the current scheme, on the basis that the Buy-Back price will be an amount of the Reference Price (which reflects the latest market value of the A Pty Ltd share) minus the tender discount accepted by the Board. Noting that the discount could be in the range of X% to Y%, the Buy-Back price will be no greater than the market value of the shares at the time of the Buy-Back if the Buy-Back did not take place and was never proposed to take place. 7. Therefore, paragraph 202-45(c) of the ITAA 1997 will not apply to deem any amount of the Buy-Back price to be an unfrankable distribution. | Detailed Reasoning - Question 2: Is the market value methodology adopted and applied by A Pty Ltd in determining the market value of its shares (i.e., the Reference Price under the Buy-Back scheme) appropriate for the purposes of applying paragraph 202-45(c) of the ITAA 1997 and section 159GZZZQ of the ITAA 1936, such that subsection 159GZZZQ will not apply to deem the Reference Price to be a higher amount? | Summary: The Commissioner finds the market value methodology adopted by A Pty Ltd in determining the market value of its shares under the scheme acceptable. | Detailed Reasoning - Detailed reasoning: 8. The Commissioner accepts that the market value methodology adopted and applied by A Pty Ltd in determining the market value of its shares (i.e., the Reference Price under the Buy-Back scheme) is appropriate for the purposes of applying section 202-45(c) of the ITAA 1997 and section 159GZZZQ of the ITAA 1936, such that subsection 159GZZZQ will not apply to deem the Reference Price to be a higher amount. | Detailed Reasoning - Question 3: Will the Commissioner make a determination under subsections 45B(3) and 45C(3) of the ITAA 1936, that a franking debit applies to the Capital Component of the Buy-Back. | Summary: The Commissioner will not make a determination under subsections 45B(3) and 45C(3) of the ITAA 1936. | Detailed Reasoning - Detailed reasoning: 9. Having regard to the 'relevant circumstances' of the scheme (the Buy-Back), as set out in subsection 45B(8) of the ITAA 1936, the Commissioner will not make a determination under section 45B that section 45C applies to the whole, or any part of the Capital Component of the Buy-Back Price. | Detailed Reasoning - Question 4: Will the Commissioner make a determination under paragraph 204-30(3)(a) of the ITAA 1997 to debit A Pty Ltd's franking account? | Summary: The Commissioner will not make a determination under paragraph 204-30(3)(a) of the ITAA 1997. | Detailed Reasoning - Detailed reasoning: 10. Section 204-30 of the ITAA 1997 applies where a corporate tax entity streams the payment of dividends, or the payment of dividends and the giving of other benefits, to its members in such a way that: (a) an imputation benefit is, or apart from this section would be, received by a member of the entity as a result of the distribution or distributions [1] (b) the member would derive a greater benefit from franking credits than another member of the entity, [2] 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. [3] 11. Relevantly, if section 204-30 of the ITAA 1997 applies the Commissioner may make one or more of the following determinations set out in subsection 204-30(3) of the ITAA 1997, that: [4] (a) a specified franking debit arises in the franking account of the entity, for a specified distribution or other benefit to a disadvantaged member, (b) a specified exempting debit arises in the exempting account of the entity, for a specified distribution or other benefit to a disadvantaged member, or (c) no imputation benefit is to arise in respect of a distribution that is made to a favoured member and specified in the determination. 12. For section 204-30 of the ITAA 1997 to apply, members to whom distributions are streamed must derive a greater benefit from imputation benefits than the members who do not participate in the Buy-Back. The words 'derives a greater benefit from franking credits' (imputation benefits) are defined in subsection 13. 204-30(8) of the ITAA 1997 by reference to the ability of the members to fully utilise imputation benefits. 14. Having had regard to the structure of the A Pty Ltd's Buy-Back, the Commissioner is of the opinion that members who participate in the Buy-Back will derive a greater benefit from imputation benefits than the non-resident members who are unable to participate in the Buy-Back. However, in accordance with paragraph 142 of Practice Statement Law Administration 2007/9: Share buy backs (PSLA 2007/9), as the Commissioner intends to exercise his discretion under section 177EA of the ITAA 1936, he will not make a determination under subsection 204-30(3) of the ITAA 1997. | Detailed Reasoning - Question 5: Will the Commissioner make a determination under paragraph 177EA(5)(a) of the ITAA 1936 to debit A Pty Ltd's franking account? | Summary: The Commissioner will make a determination under paragraph 177EA(5)(a) of the ITAA 1936 to debit A Pty Ltd's franking account, based on the percentage of A Pty Ltd's shares held by non-resident shareholders. | Detailed Reasoning - Detailed reasoning: 15. Section 177EA of the ITAA 1936 is a general anti-avoidance rule intended to apply to schemes to obtain a tax advantage in relation to imputation benefits. 16. The operative provision of section 177EA of the ITAA 1936 is subsection 177EA(3), which states: 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. 17. Pursuant to paragraph 177EA(14)(b) of the ITAA 1936, the meaning of 'scheme for a disposition of membership interests or an interest in membership interests' includes a scheme that involves the entering into any contract or transaction or dealing that changes or otherwise affects the legal or equitable ownership of membership interests or an interest in membership interests 18. A Buy-Back of A Pty Ltd shares would constitute a scheme for a disposition of membership interests and paragraph 177EA(3)(a) of the ITAA 1936 is satisfied. 19. The A Pty Ltd's Buy-Back will result in the payment of a frankable distribution and the distribution is expected to be franked. Accordingly, subparagraph 177EA(3)(b)(i) and paragraph 177EA(3)(c) of the ITAA 1936 are satisfied. 20. Paragraph 177EA(3)(d) of the ITAA 1936 is met, as A Pty Ltd shareholders would receive, or be reasonably expected to receive, imputation benefits as a result of the distribution. 21. Paragraph 177EA(3)(e) of the ITAA 1936 requires a conclusion, having regard to the relevant circumstances of the scheme, about whether A Pty Ltd, the shareholders, or any other relevant party entered into the Buy-Back for a more than incidental purpose of enabling a Participating Shareholder to obtain an imputation benefit. 22. Circumstances which are relevant in determining whether any person has the requisite purpose include, but are not limited to, the relevant circumstances included in subsection 177EA(17) of the ITAA 1936. 23. The most relevant circumstances is in paragraph 177EA(17)(b) of the ITAA 1936, which states: 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. 24. Under the current scheme, only resident shareholders of A Pty Ltd are eligible to participate in share Buy-Backs conducted by A Pty Ltd. In addressing the circumstance included in paragraph 177EA(17)(b) of the ITAA 1936, A Pty Ltd stated that non-resident shareholders were excluded from participating in the proposed Buy-Back: for the purposes of easier facilitation and administration of the programme. It is not a design to 'stream' the franking credits towards those shareholders who benefit more. 25. You later advised excluding shareholders from other countries: is commonplace in OMBBs and is done for clear commercial reasons relating to the desire to avoid additional costs and compliance requirements. That is, the ease of facilitation and administration of an OMBB is significantly improved if entities in those jurisdictions are excluded from the buy-back offer. 26. To support the above narrative that any franking credit benefits granted to resident shareholders who participated in the proposed Buy-Back, was merely incidental to the scheme, you referred to several quotations of Gageler J in Mills v FCT (2012 250 CLR 171. You also stated: It is significant that A Pty Ltd's non-resident shareholder population represents only X% of its share registry, particularly in the context of a relatively modest share buy-back programme that is capped at $XX million per year. The fact that A Pty Ltd has such a small non-resident shareholder population strongly points away from the existence of a more than incidental purpose of enabling a taxpayer to obtain imputation benefits because any purported purpose of avoiding 'wastage' of franking credits achieves a negligible benefit. By contrast, there are clear commercial reasons that explain why A Pty Ltd's non-resident shareholders are excluded from the OMBB- namely, it materially improves the ease of facilitation and administration of the programme. 27. Despite your view that the exclusion of the non-resident shareholder population is done for 'clear commercial reasons' to 'ease facilitation and administration of the programme', the Buy-Back allows A Pty Ltd resident shareholders' to fully use its franking credits as compared to non-residents who are excluded from participating in the Buy-Back. It should be noted this is one of the 'relevant circumstances of a scheme' listed in paragraph 177EA(17)(b) of the ITAA 1936. 28. Also, the Commissioner does not agree with your view that as A Pty Ltd's non-resident shareholders hold only X% shares in the company, any franking credit wastage based on the 'modest' buy back of $XX million achieves a 'negligible benefit'. In the Commissioner's view, although the non-resident shareholding in A Pty Ltd is X%, given the net worth of the company is over $X billion, any franking credit wastage based on A Pty Ltd's non-resident shareholding is considered to be materially significant. 29. The paragraph 177EA(17)(b) of the ITAA 1936 relevant circumstance may also be exacerbated by A Pty Ltd's plan to possibly defer annual dividend payments for up to four years while still conducting annual share buy-backs (where only resident shareholders can participate and obtain franking credits). Franking credits that would normally be paid to all shareholders (both resident and non-resident) as annual dividends, may be withheld for possibly up to four years, and only be paid to resident shareholders who can participate in the annual share Buy-Back. 30. Accordingly, it is the Commissioner's view the proposed scheme allows resident shareholders of A Pty Ltd to 'derive a greater benefit of franking credits than other entities who hold membership interests' (i.e. non-resident shareholders of A Pty Ltd), in accordance with paragraph 177EA(17)(b) of the ITAA 1936. 31. The phrase 'greater benefit from franking credits' is non-exhaustively defined in subsections 177EA(18) and (19) of the ITAA 1936 for indirect distributions. For direct distributions to participating shareholders, the Note to subsection 177EA(19) of the ITAA 1936 refers to subsections 204-30(7) to (10) of the ITAA 1997. For indirect distributions, paragraph 177EA(19)(a) of the ITAA 1936 specifically warns of a circumstance where one shareholders obtains a greater benefit from franking credits than an entity referred to in paragraph 177EA(17)(b) of the ITAA 1936, if that other entity 'is not an Australian resident.' 32. Subsection 204-30(8) of the ITAA 1997 also lists the circumstances that are relevant to a Participating Shareholder. Specifically, paragraph 204-30(8)(a) of the ITAA 1997 identifies the greater attraction of franking credits attached to the Dividend Component to resident Participating Shareholders than for foreign resident shareholders. 33. Example 3.3 of the Explanatory Memorandum (EM) to the New Business Tax System (Imputation) Bill 2002 , which introduced section 204-30 of the ITAA 1997, states: | Detailed Reasoning - Example 3.3: Share buy-back - excess credits: A corporate tax entity has excess franking credits - that is, more franking credits than it is reasonably likely to use to frank its ordinary distributions. It buys back shares off-market predominantly from members most able to benefit from imputation credits because the terms of the buy-back are not attractive to the other members . As a result of the buy-back it uses profits it would not normally distribute, thereby directing a large franked distribution predominantly to those who benefit most from imputation credits. This would be streaming. In this case avoiding wastage of franking credits is not a matter of concentrating scarce credits - there may well be sufficient credits to frank distributions to other members. (This type of arrangement may result in a proportionately greater interest in the corporate tax entity being held by members less able to benefit from imputation credits, and a value shift in favour of the shares not bought back. In these cases the remarks in paragraph 3.34 concerning deferral strategies may also be applicable) [emphasis added]. 34. The above concern is specifically referred to in paragraphs 115 to 117 in PSLA 2007/9 as to when section 177EA of the ITAA 1936 should be applied: 115. 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 (see Example 5 at paragraph 126 of this practice statement) • 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. 116. The ATO will challenge arrangements that cause an avoidance of 'wastage' of franking credits outside of shareholding patterns. The Explanatory Memorandum to section 177EA of the ITAA 1936 makes it patently clear that it is expected that wastage of franking credits will occur. A commonly encountered situation concerns the presence of non-residents on a company's shareholder register. A typical off-market share buy-back will stream dividends away from non-residents to residents, thus attracting the provision (see Example 5 at paragraph 126 of this practice statement). | Detailed Reasoning - The discretion in subsection 177EA(5): 117. Section 177EA of the ITAA 1936 is widely drafted, as an anti-avoidance provision, and invariably applies to most off-market share buy-backs. A survey of Class Rulings issued by the ATO will bear this out. [emphasis added] 35. Accordingly, in the Commissioner's view, paragraph 177EA(17)(b) of the ITAA 1936 is an important factor in reaching the view that the current scheme was done for a more than incidental purpose to allow resident shareholders to obtain a tax benefit. | Detailed Reasoning - Paragraphs 177EA(17)(c) & (d) of the ITAA 1936 - corporate tax entity retaining franking credits: 36. Paragraph 177EA(17)(c) of the ITAA 1936 looks at whether, apart from the scheme, the corporate entity would have retained the franking credits or would have used the franking credits to pay a franked dividend to another entity referred to in paragraph 177EA(17)(b) of the ITAA 1936. In regard to this relevant circumstance, A Pty Ltd stated: A Pty Ltd has a policy of paying dividends. Apart from the Buy-Back, the franking credits would be retained within the general franking credit reserves of A Pty Ltd for the future benefit of shareholders in the ordinary course of A Pty Ltd distributions. As at 31 December 20XX, A Pty Ltd's franking surplus was $XX million. It is envisaged that with healthy performance, dividends will continue to be paid and be fully franked for the foreseeable future on a sustainable basis. [5] 37. It is your view the paragraph 177EA(17)(c) of the ITAA 1936 relevant circumstance 'does not support an inference that there is a more than incidental purpose of enabling a taxpayer to obtain imputation benefits' as in the absence of the Buy-Back, the franking credits would be retained by A Pty Ltd and distributed to shareholders in accordance with A Pty Ltd's dividend policy. 38. The Commissioner does not agree with the above views. The Buy-Back avoids any wastage of franking credits, by deliberately excluding non-resident shareholders from participating. A Pty Ltd itself acknowledges, that if the Buy-Back did not occur, it would have retained the franking credits and paid these as part of a general dividend to all shareholders (resident and non-resident shareholders alike). In the Commissioner's view the above facts comes within the circumstances indicative of purpose under paragraph 177EA(17)(c) of the ITAA 1936. 39. It should also be noted that while A Pty Ltd has a history of distributing fully franked dividends to its shareholders, in 20XX the company announced a new policy, where dividend payments may be deferred for possibly up to four years. However, during this possible dividend deferment period, A Pty Ltd still intends to conduct annual off-market share Buy-Backs. This provides A Pty Ltd with the ability to still make annual franked distributions during the possible dividend deferment period under the proposed Share Buy-Back scheme, but only to resident Participating Shareholders. 40. Accordingly, franking credits which are used in these off-market share Buy-Backs (which non-resident shareholders are not eligible to participate) would otherwise be retained by A Pty Ltd to pay normal dividends to all A Pty Ltd's shareholders. This is confirmed by A Pty Ltd's own statement quoted in paragraph 35 above. 41. In the Commissioner's view, the Buy-Back comes within the circumstances warned against in paragraph 8.86 of the EM to Taxation Laws Amendment Act (No 3) 1998 for paragraph 177EA(17)(c) of the ITAA 1936, which states: It is also relevant to enquire whether, as a result of the scheme, maximum value is derived from the franking credits and wastage is avoided (i.e., the franking credits end up in the hands of taxpayers who can make most use of them and are not wasted by being distributed to taxpayers who would not gain the same benefit, or by remaining undistributed in the company's franking account). If the relevant taxpayer derives no additional advantage over anyone else from franking credits it is less likely that the requisite purpose is present; conversely, if the taxpayer does obtain such an advantage, that may point to the existence of the requisite purpose. [Item 25; new paragraph 177EA(19)(c)]. [6] 42. Even if A Pty Ltd does not defer any dividend payments, any franking credits used for the proposed Share Buy-Backs, means these franking credits cannot be retained or used by the company to pay normal dividends to all A Pty Ltd's shareholders (including non-resident shareholders). 43. Accordingly, paragraphs 177EA(17)(c) and (d) of the ITAA 1936 [re indirect franked distributions] support the requisite purpose. | Detailed Reasoning - Paragraph 177EA(17)(g) of the ITAA 1936 - whether a deduction allowable or capital loss incurred in connection with a distribution: 44. Paragraph 177EA(17)(g) of the ITAA 1936 examines: 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. 45. Paragraph 8.89 of the EM to Taxation Laws Amendment Act (No 3) 1998 states: In some schemes the franking credit benefit is captured by matching the franked dividend or distribution with an associated allowable deduction or capital loss. The deduction or loss in effect relieves the dividend or distribution from tax, enabling the franking rebate or franking credit to be used to shelter other income from tax. Accordingly, it is relevant to note whether there is an associated allowable deduction or capital loss under the scheme. 46. It is your view paragraph 177EA(17)(g) of the ITAA 1936 is not a relevant factor to the Buy-Back and refer to paragraph 8.89 of the EM to Taxation Laws Amendment Act (No 3) 1998 and the following to support your view: This factor points away from the existence of a more than incidental purpose of enabling a taxpayer to obtain imputation benefits because the OMBB does not incorporate any deduction or loss that would relieve the frankable distribution from taxation as contemplated by the example above. The possibility that some A Pty Ltd shareholders may realise a loss in connection with the OMBB is irrelevant because that outcome will depend on each shareholder's cost base in its A Pty Ltd shares, A Pty Ltd's average capital per share, and the operation of Division 16K, rather than any feature of the OMBB itself. [7] 47. The Commissioner does not agree with your view. The ambit of paragraph 177EA(17)(g) of the ITAA 1936 is not limited to only the situation described in paragraph 8.89 of the EM to Taxation Laws Amendment Act (No 3) 1998 . This is evident in the beginning words of paragraph 8.89 of the EM, 'In some schemes...'. Paragraph 8.89 of the EM merely provides an example of when paragraph 177EA(17)(g) may apply. 48. It is also your view any claim by A Pty Ltd shareholders' obtaining a capital or revenue loss under the share Buy-Back would be 'irrelevant' as: The scheme in Division 16K recognises the potential for an OMBB to result in a capital or revenue loss and addresses that issue through specific the market value adjustment mechanism in s159GZZZQ(2). [8] 49. The Commissioner does not agree the tax mischief under paragraph 177EA(17)(g) of the ITAA 1936 is addressed and dealt with under subsection 159GZZZQ(2) of the ITAA 1936, so as to make paragraph 177EA(17)(g) effectively otiose. 50. Section 159GZZZQ(2) of the ITAA 1936 applies to deem the sale consideration of a share in an off-market share buy-back to be its market value, if the buy-back price of the share is less than its market value, and does not address franking imputation benefit issues. This is to ensure that an assessable gain cannot be artificially reduced and a tax or capital loss cannot be artificially created. While paragraph 177EA(17)(g) of the ITAA 1936 examines whether a share buy-back scheme creates a revenue or capital loss, this is done in the context of allowing a taxpayer to use the franking credits from the share buy-back to shelter other income from tax. 51. An off-market buy-back of shares often gives rise to a capital loss for many shareholders because only the amount debited to the share capital account of the company (which can be increased by the application of the market value rule in subsection 159GZZZQ(2) of the ITAA 1936) is counted as capital proceeds [9] when working out the capital gain or capital loss from CGT event A1 happening on the buy-back of a share. A Pty Ltd acknowledged that this may occur for some of its shareholders under the proposed Share Buy-Back scheme: Shareholders in A Pty Ltd would have purchased their shares in A Pty Ltd at different times and also at different prices over the years. Depending on the purchase price of the shares in A Pty Ltd, it is possible that a capital or revenue loss be recognised as a result of the Buy-Back, consistent with the provisions of Division 16K and subject to any market value adjustment under section 159GZZZQ(2 ). [10] 52. Accordingly, paragraph 177EA(17)(g) supports the requisite purpose. | Detailed Reasoning - Paragraph 177EA(17)(j) of the ITAA 1936 - matters referred to in subsection 177D(2) of the ITAA 1936: 53. Under paragraph 177EA(17)(j) of the ITAA 1936 the matters referred to in subsection 177D(2) of the ITAA 1936 also require consideration. In support for your view that the Buy-Back was established for commercial reasons and any purpose of enabling shareholders to obtain imputation benefits is no more than an incidental purpose, you made the following points in relation to paragraph 177EA(17)(j): • the OMBB reflects an ordinary commercial process that many companies utilise and is being entered into by A Pty Ltd for ordinary commercial and capital management reasons- namely, to provide liquidity to shareholders in a typically illiquid stock to prevent the dilution of A Pty Ltd's earnings per share to assist in maintaining A Pty Ltd's favourable financial metrics. • the form and substance of the OMBB are aligned and reflect the purposes described above. • the change in A Pty Ltd's financial position will include a reduction in net assets equal to the funds used to effect the OMBB, whilst also improving A Pty Ltd's financial metrics as a consequence of the reduced liquidity and shares on issue. • the OMBB will be established and undertaken on arm's length terms and there is no relevant connection between A Pty Ltd and its shareholders, aside from the fact that A Pty Ltd's shareholders are members of the company. [11] 54. The Commissioner already considered these points when examining all the relevant circumstances under subsection 177EA(17) of the ITAA 1936. 55. As observed by Emmett J in Mills v Federal Commissioner of Taxation [2011] FCA 205, many of the matters referred to in subsection 177D(2) have no application beyond the extent to which those circumstances have already been taken into account for the other circumstances in subsection 177EA(17) of the ITAA 1936. In relation to the Buy-Back, the Commissioner considers that the matters raised by paragraph 177EA(17)(j) of the ITAA 1936 have already been taken into account in considering the other circumstances in subsection 177EA(17) of the ITAA 1936. 56. Having regard to all the circumstances of the scheme discussed above, but with particular weight attributed to paragraph 177EA(17)(b) of the ITAA 1936, in the Commissioner's view paragraph 177EA(3)(e) of the ITAA 1936 is satisfied. Therefore, section 177EA of the ITAA 1936 applies to the Buy-Back. | Detailed Reasoning - Commissioner's discretion under subsection 177EA(5): 57. 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 to deny the imputation benefits that each Participating Shareholder will receive pursuant to paragraph 177EA(5)(b) of the ITAA 1936. 58. Paragraph 22 of PSLA 2007/9 states: In relation to the exercise of the discretion in subsection 177EA(5) of the ITAA 1936: (a) the Commissioner will generally exercise his discretion in such a way that paragraph 177EA(5)(a) of the ITAA 1936 would be applied to cases where an acceptable level of discount in an off-market share buy-back is proposed (see paragraphs 117 to 126 of this practice statement), and (b) the Commissioner reserves his right to apply paragraph 177EA(5)(b) of the ITAA 1936 in cases where, inter alia, there is an unacceptable level of discount proposed (see paragraphs 117 to 126 of this practice statement). 59. Paragraphs 117 to 126 of PSLA 2007/9 advises the Commissioner will examine the proposed maximum discount level / minimum buy-back price in any off-market buy-back arrangement and regards the discount level as a relevant consideration in the exercise of his discretion. The maximum acceptable level of discount under a tender process buy-back is XX% to the closing VWAP. 60. It is your view that even if the Commissioner held that section 177EA of the ITAA 1936 applied to the proposed Buy-Back, he should exercise his discretion not to impose a franking debit under paragraph 177EA(5)(a) of the ITAA 1936 'because the quantum of any debit would be a result of A Pty Ltd's negligible non-resident population. [12] 61. The Commissioner is of the view a X% non-resident shareholding is materially significant, given that A Pty Ltd has a net value of approximately $X billion and the diversity and number of shareholders in A Pty Ltd. The Commissioner considers it appropriate to make a determination under paragraph 177EA(5)(a) of the ITAA 1936 to debit A Pty Ltd's franking account and that the debit should be based on the formula in paragraph 126 and Example 5 of PSLA 2007/9: Number of shares x Franking credit attaching x % of non-resident shareholders x 0.5 bought back to each share [1] Paragraph 204-30(1)(a) of the ITAA 1997. [2] Paragraph 204-30(1)(b) of the ITAA 1997. [3] Paragraph 204-30(1)(c) of the ITAA 1997. [4] Paragraph 204-30(3)(a) of the ITAA 1997. [5] Page X of Ruling application. [6] Note, current subsection 177EA(17) of the ITAA 1936 was previously referred to as subsection 177EA(19). [7] Page X of your email [8] Ibid [9] Subsections 159GZZZQ(1), (3) and (4) of the ITAA 1936. [10] Page XX of Ruling application. [11] Page x of your email. [12] Page x of your email.