In the 2022-23 Federal Budget, the Federal Government made the surprise announcement that the tax law would be amended to align the tax treatment of off-market share buy-backs conducted by listed public companies with that of on-market share buy-backs.
In particular, the Federal Government has taken the view that the concessional tax treatment provided under the off-market share buy-back regime results in a significant franking credit leakage and a mechanism to stream franking credits to taxpayers with low marginal tax rates, rather than to a company’s shareholders in a proportionate manner.
On 17 November 2022, the Federal Government released an exposure draft of the Treasury Laws Amendment (Off-Market Share Buy-Backs) Bill 2022 (Exposure Draft). The Exposure Draft proposes the following changes:
- where a listed public company undertakes an off-market buy-back of a share or non-share equity interest:
- no part of the purchase price in respect of the buy-back is taken to be a dividend; and
- a franking debit arises in the company’s franking account;
- a distribution by a listed public company that is consideration for the cancellation of a membership interest in itself as part of a selective reduction of capital:
- is unfrankable; and
- results in there being a debit to the company’s franking account.
The measures generally apply to off-market share buy-backs and selective reductions of capital undertaken by listed public companies that are first announced to the market (or, where there is no announcement, that occur) after 7.30pm AEDT on 25 October 2022.
KWM is planning to submit a response to the consultation on the Exposure Draft, which ends on 9 December 2022. Should you wish to discuss the Exposure Draft and its potential impact, please contact one of the authors or your KWM contact.
Key observations
- The proposed measures reflect an apparent policy decision that the current ‘leakage’ of franking credits through the existing off-market (selective) share buy-back rules is too great. Combined with the recent exposure draft legislation regarding franked distributions funded by equity raisings (our Alert on this measure can be found here), the Federal Government is seeking to prevent entities from providing franking credits to shareholders in what it considers are inappropriate circumstances.
- Off-market share buy-backs and selective reductions of capital announced before the 2022-23 Federal Budget should not be subject to the new rules.
- It will be important that the proposed measures ensure there is proper alignment, from a legal and Australian Taxation Office (ATO) administrative perspective, between off-market and on-market buy-backs. Therefore, we hope that the Federal Government and the ATO will provide assurances to the market that other aspects of the tax laws (e.g. the ‘capital streaming’ rules in section 45B of the Income Tax Assessment Act 1936 (Cth) (1936 Act)) will be applied with respect to the new provisions in the same way as they have previously been applied to on-market share buy-backs.
- The use of share buy-backs and selective reductions of capital resulting in share cancellations are important capital management tools (irrespective of their tax treatment). The off-market buy-back arrangements in particular have been commonplace amongst Australian listed public companies. The change to the ability of listed public companies to undertake off-market buy-backs is likely to have unintended consequences in relation to the capital management programs of many listed companies. It is likely to significantly narrow the capital management options available to listed public companies. The authors are of the view that tax policy decisions should not have this practical effect.
The Exposure Draft
Alignment of on-market and off-market share buy-backs
The Exposure Draft proposes amending the off-market share buy-back rules to provide separate rules for listed public companies and other companies. Where a listed public company undertakes an off-market buy-back of a share or non-share equity interest, no part of the purchase price in respect of the buy-back will be taken to be a dividend. Therefore, shareholders in listed companies will no longer be able to receive a part of the purchase price from the sale of their shares to the company as a franked dividend. Rather, a shareholder will be taken to have received the entire purchase price in respect of the buy-back as consideration for the sale of their share (or non-share equity interest) for the purposes of determining whether an amount is assessable income, deductible, or gives rise to a capital gain or loss for the shareholder.
In addition, despite the fact that no part of the purchase price in respect of the buy-back will be taken to be a dividend, in circumstances where a part of the purchase price is debited to an account other than share capital, the proposed amendments will result in a listed public company’s franking account being debited. The amount of the debit in those circumstances will be broadly equal to the debit that would have arisen if the company were not a listed public company. This is consistent with the on-market share buy-back rules.
Practically, this is likely to result in listed public companies debiting the entire purchase price in respect of the buy-back to share capital. We discuss this further below.
Share cancellations as part of selective reductions of capital
The Exposure Draft also proposes introducing new provisions regarding selective reductions of capital. The effect of these provisions will be that any distribution by a listed public company that is consideration for the cancellation of a membership interest in itself, as part of a selective reduction of capital, will be unfrankable.
The term “selective reduction of capital” is intended to be broad and to take its ordinary meaning under the Corporations Act 2001 (Cth), applying to a reduction of capital that in substance results in a disproportionate cancellation of membership interests.
Again, despite the amount of the distribution being unfrankable, in circumstances where a part of the distribution is debited to an account other than share capital, the proposed amendments will result in the listed public company’s franking account being debited. The amount of the debit in those circumstances will be broadly equal to the debit that would have arisen if the company were not a listed public company. This is to ensure alignment across the capital management activities of listed public companies as a result of the proposed amendments to the off-market share buy-back rules.
Practically, this is again likely to result in listed public companies debiting the entire purchase price in respect of selective reduction of capital to share capital.
Potential issues
Other relevant tax laws: the Exposure Draft gives effect to an apparent policy decision of the Federal Government to treat on and off-market share buy-backs by listed public companies equally from a tax perspective. However, there are other ancillary tax provisions that are relevant to share buy-backs that are not mentioned in the Exposure Draft or the explanatory materials to the Exposure Draft. It will be important that the ATO administers these provisions in the context of off-market share buy-backs by listed public companies in the same way as it currently does for on-market share buy-backs so as to not give rise to unintended consequences and to not distort capital markets and capital management decisions.
For example, the ATO has traditionally taken the position that the ‘capital streaming’ rules in section 45B of the 1936 Act should not apply where the entire proceeds of an on-market share buy-back are debited to a company’s share capital account (and thus there is no debit to the company’s franking account). In aligning the tax effects of on-market and off-market buy-backs, the same position should be taken for off-market share buy-backs conducted by listed public companies. The ATO should provide appropriate guidance on this issue.
Selective reduction of capital: the term “selective reduction of capital” is intended to be broad and to take its ordinary meaning (as indicated in the explanatory materials to the Exposure Draft). Therefore, there is the potential for the amendments to apply to an intended pro-rata (equal) reduction of capital that, for some reason unrelated to tax, is a selective reduction of capital. For example, foreign securities laws may prevent a foreign shareholder of an Australian resident company from participating in a reduction of capital. The Exposure Draft should be amended, or the ATO should provide guidance (for example, in the form of a Law Companion Ruling), to ensure this outcome does not arise.
