Private ruling: Share buy-back
Date of advice: 15 October 2015
Published: October 2015
Ruling period: Year of income ended 30 June 20YY | Year of income ended 30 June 20ZZ
Date scheme commenced: 1 July 20XX

Ruling: Q1: Will section 159GZZZQ of the Income Tax Assessment Act 1936 (ITAA 1936) apply to the proposed share buy back? | A1: No | Q2: Will subsection 202-45(c) of the Income Tax Assessment Act 1997 (ITAA 1997) apply to the proposed share buy back? | A2: No | Q3: Will the Commissioner make a determination pursuant to section 45A of the ITAA 1936 that section 45C of the ITAA 1936 applies to the proposed share buy back? | A3: No | Q4: 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? | A4: No | Q5: Will the value shifting rules in Part 3-95 of the ITAA 1997 apply to the proposed share buy back? | A5: No | Q6: Is there a scheme to which section 177EA of the ITAA 1936 applies? | A6: No

Relevant facts and circumstances: The Company is a private company incorporated a number of years ago. The Company is currently owned by two shareholders: • Shareholder 1 - X% of issued shares • Shareholder 2 - Y% of issued shares. Shareholder 1 and shareholder 2 hold their shares as trustee for their respective family trust. The families are not related. There have been no changes in the shareholding of the Company for a number of years. Both shareholders are residents of Australia for tax purposes, and neither shareholder trust has in the past distributed to non-resident beneficiaries or has any objects which are non-residents. The net assets of the Company as at 30 June 20YY was $X, represented by share capital, reserves and unappropriated profits. As at 30 June 20YY the Company had a franking account balance of $X. Due to the Company having to meet substantial debt repayments on a yearly basis, the company has not had a sufficient level of funds available to declare and pay any dividends to its shareholders. As a result, the Company has not paid any dividends (franked or unfranked) to shareholders for more than 5 years. The current market value of the Company is said to be $X, being the net assets of the Company as at 30 June 20YY. Shareholder 2 is seeking to exit the Company, and this is proposed to be undertaken by way of a selective share buy-back of all of shareholder 2's shares by the Company. Shareholder 1 does not have the capacity to fund the acquisition of the shares from shareholder 2; whereas the Company has the capacity to borrow funds secured against the land and buildings it owns to fund the buy-back. It is proposed that the Company will buy-back all the shares currently held by shareholder 2 at market value. The Company will cancel the shares following completion of the buy back. The proposed share buy-back will be accounted for in the books of the Company by a debit to the share capital account of $X with the remainder being a partly franked dividend. The proposed allocation of franking credits was negotiated on an arm's length basis. There is no intention by the continuing shareholder to wind up the Company following the buy-back. The company will continue to derive income, with shareholder 1 its sole shareholder.

Relevant legislative provisions: Section 45A Income Tax Assessment Act 1936 | Section 45B Income Tax Assessment Act 1936 | Section 159GZZZQ Income Tax Assessment Act 1936 | Section 177EA Income Tax Assessment Act 1936 | Subsection 202-45(c) Income Tax Assessment Act 1997 | Section 204-30 Income Tax Assessment Act 1997 | Section 204-70 Income Tax Assessment Act 1997 | Division 725 Income Tax Assessment Act 1997

Reasons for decision: Detailed Reasoning - Division 16K of the ITAA 1936: Division 16K of the ITAA 1936 applies to buy-backs of shares. The buy-back arrangement entered into between the Company and its shareholder is an off-market buy-back in accordance with section 159GZZZK of the ITAA 1936. Under section 159GZZZM of the ITAA 1936, the purchase price in respect of shares the company acquired through the buy-back is the amount of money the participating shareholder received or is entitled to receive as a result of or in respect of the buy- back. Under section 159GZZZP of the ITAA 1936, the purchase price will contain a dividend component if the buy-back price exceeds the amount debited against the company's share capital account. Under subsection 159GZZZQ(1) the amount of consideration deemed to be received by the seller under an off-market buy-back will be an amount equal to the purchase price in respect of the buy-back. The Company will debit its share capital account by $X. This amount has been determined by using the Average Capital Per Share method, in accordance with Practice Statement PSLA 2007/9 Share buy-backs . Therefore the dividend component of the buy-back price will be $Y. Please note that should the stated buy-back price be less than market value, the consideration received will be deemed to be market value (subsection 159GZZZQ(2). | Detailed Reasoning - Paragraph 202-45(c) of the ITAA 1997: Paragraph 202-45(c) of the ITAA 1997 provides that where the purchase price of the buy-back of a share by a company from one of its members (such as a shareholder) is taken to be a dividend under section 159GZZZP of the ITAA 1936, so much of that purchase price that exceeds the market value of the share is unfrankable. In the current case, the purchase price for the shares is stated to be market value, therefore, paragraph 202-45(c) of the ITAA 1997 will not have any application and the dividend will be a frankable distribution under section 202-40. | Detailed Reasoning - Section 45A of the ITAA 1936: Section 45A of the ITAA 1936 applies in circumstances where capital benefits are streamed to certain shareholders (the advantaged shareholders) who would derive a greater benefit from the receipt of capital benefits than other shareholders, and it is reasonable to assume that the other shareholders (the disadvantaged shareholders) have received, or will receive, dividends. In the current case there is no streaming of capital benefits to one shareholder in preference to the other shareholder. | Detailed Reasoning - Section 45B of the ITAA 1997: Section 45B of the ITAA 1936 applies where certain capital payments are paid to shareholders in substitution for dividends. In the current case, the amount debited to the Company's share capital account has been calculated in accordance with PSLA 2007/9. Accordingly, there has been no substitution of a dividend for capital payments. | Detailed Reasoning - Section 177EA of the ITAA 1936 and section 204-30 of the ITAA 1997: Section 177EA of the ITAA 1936 is a general anti-avoidance provision that applies to a wide range of schemes to obtain a tax advantage in relation to imputation benefits. Section 177EA will apply in circumstances where: (a) there is a scheme for the distribution of membership interests, or interests in membership interests, in a corporate tax entity (paragraph 177EA(3)(a) of the ITAA 1936). This includes entering into a contract, arrangement, transaction or dealing that changes or otherwise affects the legal or equitable ownership of the membership interests or interests in membership interests (paragraph 177EA(14)(b)); (b) a frankable distribution has been paid, or is payable, or expected to be payable in respect of the membership interest or has flowed indirectly, or flows indirectly, or is expected to flow indirectly in respect of the interest in membership interests (paragraph 177EA(3)(b)); (c) the distribution was, or is expected to be, a franked distribution (paragraph 177EA(3)(c)); (d) except for section 177EA, the person (the relevant taxpayer) would receive, or could reasonably be expected to receive, an imputation benefit as a result of the distribution (paragraph 177EA(3)(d)). An 'imputation benefit' includes receipt by the taxpayer of a tax offset under Division 207 of the ITAA 1997 or, in the case of a corporate taxpayer, a franking credit arising in the franking account of the taxpayer (subsection 177EA(16)); (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' (paragraph 177EA(3)(e)). The 'relevant circumstances' are defined in subsection 177EA(17) of the ITAA 1936 to include 11 matters, the last of which (in paragraph 177EA(17)(j)) includes the eight matters in paragraphs 177D(2)(a) to (h) of the ITAA 1936. In discussing the application of section 177EA of the ITAA 1936 to a share buy-back arrangement, PSLA 2007/9 provides the following guidance: 115. ........ 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. ..... In the current case, the Company does not have sufficient franking credits available to enable the share buy-back dividend to be fully franked. The exiting shareholder currently has a X% share of the company, yet franking credits to be attached to the dividend represent a different percentage of the current franking account balance. The applicant has advised that the franking credit amount was negotiated between the two shareholders, taking into account a number of factors. In the current case: • both the two current shareholders have valid family trust elections in place. Therefore both trustees would be able to pass on any franking credits received from the Company to their beneficiaries • Neither family trust has any non-resident beneficiaries or other 'tax advantaged' beneficiaries that could cause them to want to stream the franking credits a particular way • The two current shareholders have agreed on this approach • There is nothing that points to an arrangement that has been designed to avoid a potential wastage of franking credits. Accordingly, section 177EA of the ITAA 1936 will not apply to the arrangement. | Detailed Reasoning - Division 725 of the ITAA 1997: Division 725 of the ITAA 1997 may apply if under a scheme, value is shifted from equity or loan interest in a company to other equity or loan interest in the same company. In the current case, the shares are stated to be purchased at market value, therefore there is no value shifting occurring and the provisions of Division 725 of the ITAA 1997 will not have any application. However, should the purchase price not represent true market value, the provisions of Division 725 of the ITAA 1997 may have application.