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Will Division 16K of Part III of the Income Tax Assessment Act 1936 (ITAA 1936) deem the difference between the market value of the shares bought back and the amount paid by the company to the shareholder to be a dividend?

No. The difference between the amount paid for the share and the market value will not be a deemed dividend.

The taxpayer, an individual, acquired his/her entire shareholding in the company before 20 September 1985.

The company now proposes to buy-back a majority of the shares on issue at their face value and debit the full purchase price against the credit standing in the company's share capital account.

The market value of the shares exceeds their face value.

The buy-back arrangement is an off-market purchase in accordance with the explanation of terms in section 159GZZZK of the ITAA 1936.

Subdivision C of Div 16K (sections 159GZZZP and 159GZZZQ) of the ITAA 1936 sets out the tax consequences for a shareholder who sells shares to a company in an 'off market purchase'.

Section 159GZZZP of the ITAA 1936 deals with the treatment of the purchase price in an off-market buy-back situation. It acts to treat the difference between the purchase price and that part of the purchase price (if any) which is debited against a credit in the company's share capital account as a dividend paid by the company to the seller out of the company profits on the day the buy-back occurs.

In this case as the full purchase price will be debited against the credit standing in the company's share capital account, no amount is taken to be a dividend deemed or otherwise.

Subsection 159GZZZQ(1) of the ITAA 1936 provides that the buy-back price of the share is, for general income tax and Capital Gains Tax purposes, the amount actually received. If the full purchase price is less than the share's market value, the market value is used as the disposal consideration (subsection 159GZZZQ(2)) of the ITAA 1936.

In this case the market value of the shares bought back does exceed the buy back price, however the transaction is not caught by any general income tax provision as the shares were not acquired or held for instance for the purpose of obtaining a profit on resale nor were they held as trading stock.

A capital gain however has been made as the deemed capital proceeds, in terms of section 116-30 of the Income Tax Assessment Act 1997 (ITAA 1997), equals the market value of the shares. However the capital gain is exempt in terms of paragraph 104-10(5)(a) of the ITAA 1997, as the shares were acquired before 20 September 1985.