Implications Of Off-Market Buy-Back Of Shares On Capital Gains Taxation In Australia

Division of Payment by the Bank into Capital and Dividend Components

Tranche is a French word and denotes a slice or portion. When implied into the investment world, it implies that a security/stock has been split up in small portions and sold to the company/investor. In this case study of Simon Krupcheck[1], the banks, to whom Simon sold-back the shares had started the buy-back process by buying back some of their own shares. When Simon sold back the shares to the bank, in tranches, the bank immediately cancels the shares, as it cannot be an investor on its own behalf.

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As soon as the first tranche is received by the bank, it makes payment to Simon by splitting it into two components[2]: (a) the capital component and (b) the dividend component. The amount debited to the bank’s share capital account will denote the capital component of the tranche and the balance of the payment will be treated as the dividend component and will be franked.

After the split into capital and dividend components by the bank, the Australian Taxation Office (ATO) starts investigating the implications of anti-avoidance and the integrity measures as per the applicable income tax laws[3], especially under TD 2004/22, PS LA 2007/9 and subsection 159GZZZQ(2) of the Income Tax Assessment Act, 1936. The purpose is to ensure that neither the seller nor the buyer take any inappropriate tax benefit from the buy-back. Hence, ATO’s primary concern is the distribution of the allocated payment between the capital and dividend components.

Tax liability of Simon will be determined by the bank’s splitting of the payment. However, while making the payment, the bank has to consider that since the tranche transactions are not being routed through the Market/Exchange and is being conducted as a direct buyback from the shareholder (known as an off-market deal) there will be no Securities Transaction Tax (STT), hence the ATO will apply the Capital Gains rule.

The ATO will bring into effect Tax Determination 2004/22[4] (TD 2004/22) for evaluating the market value of the shares transacted. TD 2004/22 has ruled that tax implication for off-market buy-back of shares, whether the price of the buy-back has been set through a tender process or not, will be determined by applying subsection 159GZZZQ(2) of the Income Tax Assessment Act, 1936 (ITAA 1936)[5].

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Subsection 159GZZZQ(2) of ITAA 1936 specifies that tax implication for all off-market buy-back of all share belonging to listed companies will be based on the market value of the shares at the time of the buy-back. This will be determined through the Volume Weighted Average Price (VWAP), on the ASX, of the bank’s share over a period of last five trading days, before the announcement of the buy-back’s first tranche[6].

ATO’s Application of Capital Gains Tax Rule

This is done after adjusting the percentage changes in the S&P/ASX 200 Index, from the time of trading of the first announcement date (termed as the Opening S&P/ASX 200 Index) to the close of the trading of the S&P/ASX 200 Index, when last transaction of the buy-back is closed (termed as the Closing S&P/ASX 200 Index)[7]. The formula used is:

However, for all practical purposes, the ATO cannot fulfil all the Principles and Concepts of the taxation law, for the implementation of subsection 159GZZZQ(2), until all the relevant information and surrounding circumstances are known, including the final buy-back price for evaluating the precise calculation of the tax to be implied.

Conclusion

In Para 12, which relates to ‘Share Buy-backs’, of the Practice Statement PS LA 2007/9, the ATO states, and I quote: “…prima facie, the Average Capital Per Share [ACPS] methodology is the preferred methodology for determining the ‘Dividend/Capital Split’ in an off-market share buy-back. In the absence of exceptional circumstances, Average Capital Per Share will be applied to determine the capital component.” Unquote. 

On the basis of the above explanations and discussion, it is evident that the ATO has a relevant case of implying Capital Gains/Loss rules on Simon for the transactions which were conducted by Simon with various banks for off-market sale of shares[8]. Since Simon was using an online software for maintaining all records of his transactions, there is no doubt that ATO will be able to verify all the facts from the data available on the online software system. In conclusion, Simon will be able to claim the capital loss of $50,000 from the transactions and report it through his current income statement[9].

Understanding Fringe Benefit

As per Fringe Benefits Tax Assessment Act, 1986 (FBTAA, 1986) and Income Tax Assessment Act, 1997 (ITAA, 1997) ‘Fringe Benefits’ are defined[10] as benefits provided by Contemporary Clothes Co (CCC) to Lucy, as an employee, for providing comfort and convenience to her for increasing her workplace output. Broadly, the following benefits, defined under the Act, are covered as facilities that CCC can provide to Lucy under the FBTAA, 1986:

  • Use of a car owned by CCC for personal & official purposes.
  • Travel Allowance for Official purposes.
  • Loans at interest rates lower than market rates.
  • Membership Fee of Lucy’s club.
  • Lucy’s expenses on personal entertainment.
  • Miscellaneous personal expenses of Lucy, such as her children’s school fee.

Such amounts will not be included in the assessable income of Lucy, as stated under ss 6-5 and 6-10 of ITAA, 1997 and sub-section 136(1) of FBTAA, 1986[11]. All fringe benefit covered under s 23L of ITAA, 1936, will also be considered as exempt incomes for Lucy. However, Lucy cannot forego part of her salary (termed as Salary Sacrifice) and let CCC pay them to her as fringe benefits. The ATO has powers to invoke the minimum wages provision and adjust the fringe benefit amount as taxable income at the hands of Lucy under provisions of ss 6-5 and 6-10 of ITAA, 1997. Under sub-section 136(1) of the FBTAA, 1986, CCC cannot get exemption from its FBT liability on such amounts[12].

Tax Laws Related to Fringe Benefits and Their Impact on the Employer and Employee

An income year, according to Taxation Laws is from July 1 to June 30, but the accounting period of fringe benefits, as per FBTAA, 1986 regulations is from April 1 to March 31. Section 32.5 of ITAA, 1997 allows CCC to claim entertainment expenses as a deductible business expense, but s 63A of FBTAA, 1986 rules that CCC is required to pay tax as per FBT rates on such entertainment expenses. Moreover, CCC is also required to include in its assessable income, all contributions made by Lucy towards the purchase cost of the fringe benefit assets which she uses. This will be applicable to the $1,000 which Lucy has contributed towards the cost of the car.

However, expenses including motor fuel payments, car repair or car insurance, which Lucy has paid directly to third party cannot be claimed by CCC in their GST statement. These will include the amount of $8,000 which Lucy spent on maintenance costs of the car and included expenses such as, registration and insurance charges, stamp duty and petrol, during the FBT Year ended 31 March 2018[13]. Lucy used $5,000 from the Concessional Loan given to her by CCC for purchasing shares of listed companies. Lucy will be liable for any Capital Gain/Loss which she collects from the sale of these shares.

The waiver of loan of $2,000 on 31 March 2018, given to Lucy’s husband Dave by CCC on 1 April 2017, will be claimed as a fringe benefit by CCC and taxed accordingly. The cost of tickets to Bali (equivalent to $3,000), which Lucy paid out of her Frequent Flyer Points cannot be claimed by Lucy as a deductible expense, as the Frequent Flyer Points were earned from her FBT traveling allowance paid by CCC[14].

Type-1 fringe benefits are inclusive of GST. However, Type-2 fringe benefits are those which are either exempt or excluded benefits under the provisions of FBTAA, 1986 and hence are free from any liability under GST[15].

CCC’s FBT amount can be calculated by using the following formula[16].

= [(Total amount of Type-1 Fringe Benefits) x (Higher Gross-up Rate)] +

    [(Total amount of Type-2 Fringe Benefits) x (Lower Gross-up rate)]

= ($(20,000 + 50,000 + 1,000) x 2.0802) + ($(10,000 + 2,000) x 1.8868)

= $(71,000 x 2.0802) + $(12,000 x 1.8868)

= $147,694.2 + $22,641.6

= $170,335.8

To calculate CCC’s Fringe Benefit Tax liability[17], the amount of FBT calculated above is to be multiplied by the applicable FBT rate of 47.0% for the FBT year ended 31 March 2018.

Hence, the Total Fringe Benefit Tax liability of CCC for the FBT Year ended 31 March 2018 will be:

= $170,335.8 x 47.0%

= $80,057.82

However, the after-tax cost[18] of the fringe benefits provided by CCC to Lucy, from the perspective of CCC will be:

= $83,000.00 – $80,057.82

= $ 2,942.18.

Alexander, Dr. R. and Fogarty, H. J., Australian Master Family Law Guide, (3rd ed.; Sydney, NSW: CCH Australia Limited, 2009).

Barkoczy, S., Australian Tax Case book (9th ed.; North Ryde, NSW: CCH Australia Limited, 2012).

Barkoczy, S., Core Tax Legislation and Study Guide (16th ed.; North Ryde, NSW: CCH Australia Limited, 2011).

Barkoczy, S., Foundations of Taxation Law (5th ed.; North Ryde, NSW: CCH Australia Limited, 2013).

Barkoczy, S., Rider, C., Baring, J. and Bellamy, N., Australian tax casebook (10th ed.; North Ryde, NSW: CCH Australia Limited, 2010).

Cassidy, J., Concise Income Tax (4th ed.; Annandale, NSW: Federation Press, 2007).

CCH, Australian Master Tax Guide (Sydney, NSW: CCH Australia Limited, 2012).

Deutsch, R. et al, Australian tax handbook. (Pyrmont, NSW: Thomson Reuters, 2011).

Marsden, S. J., Australian Master Bookkeepers Guide (3rd ed.; Sydney, NSW: CCH Australia Limited, 2010).

McCouat, P., Australian Master GST Guide (13th ed.; Sydney, NSW: CCH Australia Limited, 2012).

Nethercott, L., Devos, K. and Richardson, G., Australian taxation study manual: questions and suggested solutions (20th ed.; Sydney, NSW: CCH Australia Limited, 2010).

Renton, N. E., Family Trusts: A Plain English Guide for Australian Families of Average Means (4th ed.; Milton, QLD: John Wiley & Sons, 2012).

[1] S. Barkoczy, Core tax legislation and study guide (North Ryde, NSW: CCH Australia Limited, 2011), 162.

[2] S. Barkoczy, Foundations of Taxation Law (5th ed.; North Ryde, NSW: CCH Australia Limited, 2013), 261.

[3] S. Barkoczy et al, Australian tax casebook (10th ed.; North Ryde, NSW: CCH Australia Limited, 2010), 81.

[4] Dr. R. Alexander and H. J. Fogarty, Australian Master Family Law Guide, (3rd ed.; Sydney, NSW: CCH Australia Limited, 2009), 234.

[5] R. Deutsch et al, Australian tax handbook. (Pyrmont, NSW: Thomson Reuters, 2011), 234.

[6] L. Nethercott, K. Devos and G. Richardson, Australian taxation study manual: questions and suggested solutions (20th ed.; Sydney, NSW: CCH Australia Limited, 2010), 360.

[7] P. McCouat, Australian Master GST Guide (13th ed.; Sydney, NSW: CCH Australia Limited, 2012), 153.

[8] S. Barkoczy, Foundations of Taxation Law (5th ed.; North Ryde, NSW: CCH Australia Limited, 2013), 261.

[9] CCH, Australian Master Tax Guide (Sydney, NSW: CCH Australia Limited, 2012), 207.

[10] S. J. Marsden, Australian Master Bookkeepers Guide (3rd ed.; Sydney, NSW: CCH Australia Limited, 2010), 225.

[11] N. E. Renton, Family Trusts: A Plain English Guide for Australian Families of Average Means (4th ed.; Milton, QLD: John Wiley & Sons, 2012), 405.

[12] P. McCouat, Australian Master GST Guide (13th ed.; Sydney, NSW: CCH Australia Limited, 2012), 153.

[13] Dr. R. Alexander and H. J. Fogarty, Australian Master Family Law Guide, (3rd ed.; Sydney, NSW: CCH Australia Limited, 2009), 234.

[14] S. Barkoczy, Australian Tax Case book (9th ed.; North Ryde, NSW: CCH Australia Limited, 2012), 135.

[15] J. Cassidy, Concise Income Tax (4th ed.; Annandale, NSW: Federation Press, 2007), 144.

[16] R. Deutsch et al, Australian tax handbook. (Pyrmont, NSW: Thomson Reuters, 2011), 234.

[17] P. McCouat, Australian Master GST Guide (13th ed.; Sydney, NSW: CCH Australia Limited, 2012), 153.

 [18] S. Barkoczy, Foundations of Taxation Law (5th ed.; North Ryde, NSW: CCH Australia Limited, 2013), 261.