Income tax: share buy-back: Santos Limited

This Ruling sets out the Commissioner's opinion on the way in which the relevant provision(s) identified below apply to the defined class of entities, who take part in the scheme to which this Ruling relates.

The relevant provisions dealt with in this Class Ruling are: • subsection 44(1) of the Income Tax Assessment Act 1936 (ITAA 1936); • section 45A of the ITAA 1936; • section 45B of the ITAA 1936; • section 45C of the ITAA 1936; • paragraph 128B(3)(ga) of the ITAA 1936; • Division 16K of Part III of the ITAA 1936; • section 159GZZZP of the ITAA 1936; • section 159GZZZQ of the ITAA 1936; • Division 1A of Part IIIAA of the ITAA 1936; • subsection 160APHI(4) of the ITAA 1936; • section 160APHM of the ITAA 1936; • section 160APHO of the ITAA 1936; • section 177EA of the ITAA 1936; • section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997); • Division 67 of the ITAA 1997; • section 104-10 of the ITAA 1997; • section 116-20 of the ITAA 1997; • section 118-20 of the ITAA 1997; • section 118-25 of the ITAA 1997; • section 202-5 of the ITAA 1997; • section 202-40 of the ITAA 1997; • section 202-45 of the ITAA 1997; • section 204-30 of the ITAA 1997; • section 207-20 of the ITAA 1997; • section 207-145 of the ITAA 1997; • section 855-10 of the ITAA 1997; • section 855-15 of the ITAA 1997; • section 855-20 of the ITAA 1997; • section 855-30 of the ITAA 1997; and • section 960-195 of the ITAA 1997.

The class of entities to which this Ruling applies is the shareholders of Santos Limited (Santos), a publicly listed company, who disposed of shares under the Santos off-market share buy-back (Buy-Back) which was announced by Santos on 14 May 2007 and described in the Scheme part of this Ruling. In this Ruling, the shareholders of Santos are collectively referred to as 'shareholders' or 'participating shareholders'.

The Commissioner makes this Ruling based on the precise scheme identified in this Ruling.

The class of entities defined in this Ruling may rely on its contents provided the scheme actually carried out is carried out in accordance with the scheme described in paragraphs 13 to 28 of this Ruling.

If the scheme actually carried out is materially different from the scheme that is described in this Ruling, then: • this Ruling has no binding effect on the Commissioner because the scheme entered into is not the scheme on which the Commissioner has ruled; and • this Ruling may be withdrawn or modified.

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This Ruling applies from 1 July 2006 to 30 June 2007. However, the Ruling continues to apply after this date to all entities within the specified class who entered into the specified scheme during the term of the Ruling, subject to there being no change in the scheme or in the entities involved in the scheme.

The Ruling does not apply to taxpayers to the extent that it conflicts with the terms of settlement of a dispute agreed to before the date of issue of the Ruling. Furthermore, the Ruling only applies to the extent that: • it is not later withdrawn by notice in the Gazette ; or • the relevant taxation provisions are not amended.

If this Ruling is inconsistent with a later public or private ruling, the relevant class of entities may rely on either ruling which applies to them (item 1 of subsection 357-75(1) of Schedule 1 to the Taxation Administration Act 1953 (TAA)).

If this Ruling is inconsistent with an earlier private ruling, the private ruling is taken not to have been made if, when the Class Ruling is made, the following two conditions are met: • the income year or other period to which the rulings relate has not begun; and • the scheme to which the rulings relate has not begun to be carried out.

If the above two conditions do not apply, the relevant class of entities may rely on either ruling which applies to them (item 3 of subsection 357-75(1) of Schedule 1 to the TAA).

The following description of the scheme is based on a number of documents provided to the Commissioner. Note: certain information from Santos has been provided on a commercial-in-confidence basis and will not be disclosed or released under the Freedom of Information Legislation.

On 14 May 2007, Santos announced its intention to make an off-market buy-back of its own shares (the Buy-Back). Santos announced it would spend approximately $300 million in purchasing its ordinary shares.

As at 31 December 2006, Santos' Share Capital comprised approximately 598 million fully paid ordinary shares. The financial statements of Santos at 31 December 2006 show total share capital of $2,254.4 million, reserves of $2.4 million and retained profits of approximately $401.7 million.

The shareholders in Santos are a mix of Australian resident individuals, companies, institutions and superannuation funds, as well as non-resident shareholders.

The Buy-Back forms part of Santos' capital management strategy that aims to return capital that is surplus to its needs. Santos anticipates that the Buy-Back will have a positive effect on its share price and earnings per share.

The Buy-Back was conducted through a tender process during a specified tender period and was open to all eligible shareholders who were registered as such on the record date for the Buy-Back (23 May 2007) other than employees holding shares restricted from sale and residents of the United States of America or Canada. Shares acquired on an ex-entitlement basis on or after the Ex-entitlement date (17 May 2007) carried no entitlement to participate. Participation in the Buy-back was voluntary. Hence eligible shareholders who did not wish to participate were not required to do anything. Non-participating shareholders will not receive any property, dividend or distribution by way of compensation.

The tender period opened on 12 June 2007 and closed on 29 June 2007. Under the tender process, shareholders were able to submit offers to sell their shares at specified discount percentages within a range of 8% to 14% per share, in 1% intervals. In doing so, shareholders could also have submitted tenders to sell different parcels of shares at different percentage discounts. Alternatively, shareholders could have submitted a Final Price Tender which was the price as finally determined under the tender process.

Shareholders were also provided with a choice to nominate a Minimum Buy-Back Price (Minimum Price) in addition to the required selection of a tender discount percentage. The tender process allowed shareholders to specify one of three Minimum Prices. Shareholders who failed to nominate a discount percentage and who attempted to specify only a Minimum Price would not have their tenders accepted.

The relevant discount was applied to the volume weighted average price (VWAP) of Santos' shares over the last five trading days of the Buy-Back tender period, including the closing date.

Shareholders who tendered a discount percentage less than the accepted discount percentage determined by Santos were not accepted. Shareholders who tendered a discount percentage greater than the accepted discount percentage or at the Final Price Tender (subject to the Minimum Price) were accepted and received the Buy-Back Price for each share bought back.

Where the number of shares tendered that satisfied the Buy-Back criteria exceeded the number of shares Santos determined to buy back, shareholders with tenders equal to the accepted discount percentage (including Final Price Tenders) were scaled back on a pro-rata basis. A priority allocation of 500 shares was bought back from each successful tendering shareholder before the scale back was applied.

Notwithstanding the scale-back, any shareholder who tendered all of their shares at or below the Buy-Back Price, or as a Final Price Tender, and would have, unless otherwise determined, 200 or fewer shares as a result of the scale-back, had all of the shares they tendered bought back in full. Shareholders who held 500 shares or less, unless otherwise determined, were only permitted to tender all of their holding, not just a proportion of their holding.

All shares bought back under the Buy-Back were cancelled.

The Buy-Back Price was subject to two overriding limits: (a) Santos would not buy-back shares at a discount greater than 14% to the VWAP of Santos shares over the five (5) trading days up to and including the closing day of the tender period (29 June 2007); and (b) the Buy-Back Price would not exceed the market value of Santos shares determined in accordance with Taxation Determination TD 2004/22.

Under the Buy-Back, $2.79 per share was debited to Santos' untainted share capital account and the balance of the Buy-Back Price was debited to Santos' retained profits.

On 30 June 2007 Santos announced that: • it had successfully completed the off-market share Buy-Back of approximately 24.7 million Santos Limited ordinary shares, representing 4.1% of the issued capital of Santos Limited; • the total amount of capital repurchased under the Buy-Back was approximately $ 300 million; • the final price for the Buy-Back was set at $12.16 per share (Buy-Back Price), representing a discount of 14% to the VWAP of Santos' shares over the 5 days up to and including the closing date of the Buy-Back; • shares tendered at a discount of 14% or as a Final Price Tender were accepted in full, subject to any minimum price condition; • shares tendered at discounts from 8% to 13% were not accepted; • no tenders were excluded on the basis of a minimum price condition; and • a scale-back of (60.87%) applied, subject to paragraphs 23 and 24 of this Ruling.

Participating shareholders are taken to have been paid a dividend of $9.37 (Dividend Component) on the day the Buy-Back occurred (30 June 2007) for each share bought back under section 159GZZZP of the ITAA 1936.

The Dividend Component is a frankable distribution pursuant to section 202-40 of the ITAA 1997, and is therefore capable of being franked in accordance with section 202-5 of the ITAA 1997.

The difference between the Buy-Back Price and the Dividend Component is not a dividend for income tax purposes.

The Dividend Component of $9.37 and an amount equal to the franking credit on the Dividend Component (gross-up) is included in the assessable income of resident individual, superannuation fund and company shareholders who participate in the Buy-Back under subsection 44(1) of the ITAA 1936 and subsection 207-20(1) of the ITAA 1997 respectively in the income year in which the Buy-Back occurred.

Participating shareholders who are individual residents of Australia for tax purposes will be entitled to a tax offset under subsection 207-20(2) of the ITAA 1997 equal to the amount of the franking credit on the Dividend Component, subject to being a qualified person.

The tax offsets will be subject to the refundable tax offset rules in Division 67 of the ITAA 1997. Certain trustees and corporate tax entities are not entitled to the refundable tax offset rules because of subsections 67-25(1A) to (1D) of the ITAA 1997.

As the Dividend Component is fully franked, participating non-resident shareholders are not liable for Australian withholding tax under paragraph 128B(3)(ga) of the ITAA 1936.

Participating shareholders are taken to have received $3.85 as consideration in respect of the sale of each of their shares bought back under the Buy-Back on 30 June 2007 in accordance with section 159GZZZQ of the ITAA 1936, unless the participating shareholder is a corporate tax entity to which subsections 159GZZZQ(8) and (9) apply.

In accordance with Taxation Determination TD 2004/22 if the Buy-Back price for each share bought back under the Buy-Back was less than what would have been 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, then the market value rule in subsection 159GZZZQ(2) of the ITAA 1936 applies to the Buy-Back. The effect of this rule is that the difference between the Buy-Back Price and the market value determined in accordance with TD 2004/22 is included in the consideration received for the disposal of the share for ordinary income or capital gains tax purposes in addition to the capital amount of $2.79 per share. Accordingly, the sale consideration is $3.85.

The Sale Consideration of $3.85 represents the capital proceeds for capital gains tax purposes pursuant to section 116-20 of the ITAA 1997. A shareholder will make a capital gain on a share if the Sale Consideration per share exceeds the cost base of that share. The capital gain is the amount of the excess. Similarly, a shareholder will make a capital loss if the Sale Consideration per share is less than the reduced cost base of a share.

The shares are taken to have been disposed of for capital gains tax purposes on 30 June 2007 pursuant to section 104-10 of the ITAA 1997.

Where the shares are held as trading stock, the Sale Consideration of $3.85 is included in assessable income under section 6-5 of the ITAA 1997. Where the shares are held as revenue assets, the amount by which the Sale Consideration of $3.85 per share exceeds the cost of each share is included in the shareholder's assessable income. Correspondingly, if the cost exceeds the Sale Consideration of $ 3.85 per share the difference is an allowable deduction.

Under section 855-10 of the ITAA 1997, foreign resident shareholders that participate in the Buy-Back will only have CGT consequences if their shares bought back under the Buy-Back are 'taxable Australian property'.

For the purposes of Division 1A of former Part IIIAA of the ITAA 1936, participating shareholders will be considered to satisfy the holding period rule under section 160APHO of the ITAA 1936 and therefore be qualified persons (as long as the related payments rule is also met) in relation to the Dividend Component received under the Buy-Back if: (a) the shares sold into the Buy-Back were acquired on or before 15 May 2007; and (b) during the period when the shares or interest in the shares were held the shareholders had sufficient risks of loss or opportunities for gain in respect of the shares or interest in the shares (as defined in section 160APHM of the ITAA 1936) for a continuous period of at least 45 days. Neither the announcement of the Buy-Back, the making of an invitation to shareholders to offer to sell their Santos shares nor the making of an offer by a shareholder to Santos in respect of a Santos share will affect whether the shares bought back under the Buy-Back were held 'at risk' for the purposes of Division 1A.

A shareholder who acquired shares on or after 16 May 2007 that were subsequently accepted into the Buy-Back pursuant to the 'last-in first-out' rule is not a qualified person in relation to the Dividend Component under section 160APHO of the ITAA 1936 unless certain exceptions are met.

The 'last-in first-out' rule in subsection 160APHI(4) of the ITAA 1936 does not apply for the purposes of the Buy-Back to Santos shares acquired on or after 17 May 2007 (the ex-entitlement date), provided these shares did not confer an entitlement to participate in the Buy-Back.

The Commissioner will not make a determination under section 45A or 45B of the ITAA 1936 that section 45C of the ITAA 1936 applies to the whole, or any part, of the Capital Component of the Buy-Back Price received by participating shareholders.

The Commissioner will not make a determination under paragraph 177EA(5)(b) of the ITAA 1936 to deny the whole, or any part, of the imputation benefits received in relation to the Dividend Component of the Buy-Back Price by participating shareholders.

The Commissioner will not make a determination under paragraph 204-30(3)(c) of the ITAA 1997 to deny the whole, or any part, of the imputation benefits received in relation to the Dividend Component of the Buy-Back Price by participating shareholders.

The purchase price received by participating shareholders comprised two components: • a dividend component; and • a capital component. The amount of each of these components is determined in accordance with sections 159GZZZP and 159GZZZQ of the ITAA 1936, having regard to how the company accounts for the off-market share buy-back.

Section 159GZZZP of the ITAA 1936 provides that where the buy-back of a share is an off-market purchase, the difference between the 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 (30 June 2007). In this case the purchase price was $12.16 per share and $2.79 of this was debited to the share capital account. Thus the dividend component is $9.37 per share.

For Australian resident individual and corporate tax entity shareholders, and also for Australian complying superannuation funds, the dividend component is included in their assessable income under subsection 44(1) of the ITAA 1936. The dividend is taken to be paid by Santos on the day the buy-back occurs (30 June 2007) and accordingly assessable in the tax year the buy-back occurs. Generally, an amount equal to the amount of the franking credit is included in their assessable income under subsection 207-20(1) of the ITAA 1997 and they are also entitled to a tax offset under subsection 207-20(2) of the ITAA 1997 reflecting the franking credit attached to the dividend.

The Dividend Component of $9.37 per share 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 (paragraph 202-45(c) of the ITAA 1997). TD 2004/22 outlines how to determine what would have been 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. In this case, the Buy-Back Price did not exceed the market value determined in accordance with TD 2004/22.

Paragraph 207-145(1)(a) of the ITAA 1997 provides that in relation to a franked dividend made by an entity only 'a qualified person in relation to the distribution for the purposes of Division 1A of former Part IIIAA of the ITAA 1936' is entitled to a franking credit or tax offset. Broadly speaking, to be a 'qualified person' in relation to the dividend paid under the Buy-Back, the participating shareholder must satisfy both the holding period rule (or certain alternative rules) and the related payments rule. These two rules are discussed later in this Ruling.

Subsection 159GZZZP(2) of the ITAA 1936 provides that the difference between the Buy-Back Price and the Dividend Component is not a dividend for income tax purposes.

The tax offsets will be subject to the refundable tax offset rules in Division 67 of the ITAA 1997. Certain trustees and corporate tax entities are not entitled to the refundable tax offset rules because of subsections 67-25(1A) to (1D) of the ITAA 1997.

As the Dividend Component of the consideration received under the Buy-Back is fully franked, a non-resident shareholder is not liable to Australian withholding tax on the Dividend Component (paragraph 128B(3)(ga) of the ITAA 1936).

Participating shareholders are taken to have disposed of those shares accepted under the Buy-Back on 30 June 2007. The disposal may have different taxation implications for shareholders depending on how the shares were held, for instance: • an investor who held their shares on capital account will be subject to the capital gains tax provisions; and • a share trader who held their shares on revenue account will be subject to the ordinary income provisions.

It should be noted that shareholders who have both an income tax and a capital gains tax liability will generally have the amount of the capital gain reduced under the anti-overlap provisions contained in section 118-20 of the ITAA 1997. If the shares are held as trading stock the capital gain or loss is disregarded under section 118-25 of the ITAA 1997.

For the purposes of computing the amount of the gain or loss (on capital or revenue account) in these cases, the consideration in respect of the disposal of a share under a buy-back is determined in accordance with section 159GZZZQ of the ITAA 1936.

Subsection 159GZZZQ(1) of the ITAA 1936 provides that the shareholder is taken to have received an amount equal to the purchase price (in this case the $12.16 received for each share bought back) as consideration in respect of the sale of the share bought back. However, this amount is subject to certain adjustments in order to arrive at the Sale Consideration.

Subsection 159GZZZQ(2) of the ITAA 1936 is one of the adjusting provisions. It provides that if the purchase price is less than 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 the shareholder is taken to have received an amount equal to the market value as consideration in respect of the sale of the share bought back.

For the purposes of determining the application of subsection 159GZZZQ(2) the following methodology was proposed by Santos and accepted by the Commissioner in accordance with TD 2004/22: the market value of each share is the VWAP of the shares over the last five trading days before the first announcement of the Buy-Back, adjusted for the percentage change in the S&P/ASX Resources 200 Index from the commencement of trading on 14 May 2007 to the close of trading on 29 June 2007. Under this methodology, the market value of a share bought back under the Buy-Back was calculated to be $13.22. Thus, the shareholders are taken to have received $13.22 for the sale of each share rather than $12.16.

Pursuant to subsection 159GZZZQ(3) of the ITAA 1936, the deemed consideration of $13.22 is reduced by a 'Reduction Amount'. The Reduction Amount is an amount calculated under subsection 159GZZZQ(4) of the ITAA 1936. In the circumstances of the Buy-Back, the Reduction Amount is equivalent to the Dividend Amount, that is, $9.37 unless the seller is a corporate tax entity to whom subsection 159GZZZQ(8) applies. Therefore, the Sale Consideration for each share disposed of under the Buy-Back is $3.85 ($13.22 less $9.37).

A foreign resident shareholder can disregard any capital gain or capital loss made from the Buy-Back if their Santos shares bought back under the Buy-Back are not 'taxable Australian property' (section 855-10 of the ITAA 1997). The term 'taxable Australian property' includes an 'indirect Australian real property interest' (item 2 in the table in section 855-15 and section 855-25 of the ITAA 1997).

A Santos foreign resident shareholder will have an 'indirect Australian real property interest' if it holds a membership interest in Santos, and the interest passes both the principal asset test (section 855-30 of the ITAA 1997), and the non-portfolio interest test (section 960-195 of the ITAA 1997).

Santos have advised that the shares in Santos may pass the principal asset test at the time that the shares are bought back under the Buy-Back. The Santos share will pass the non-portfolio interest test if the sum of the direct participation interests (which include shares) held by the shareholder and its associates in Santos is 10% or more at the time that the share is bought back under the Buy-Back or throughout a 12 month period during the 24 months before the time the share is bought back under the Buy-Back (section 855-25 and section 960-195 of the ITAA 1997).

A Santos share will also be 'taxable Australian property' if the foreign resident shareholder has used their Santos share in carrying on a business through a permanent establishment in Australia (item 3 in the table in section 855-15 of the ITAA 1997).

Paragraph 207-145(1)(a) of the ITAA 1997 provides that in relation to a franked dividend made to an entity only 'a qualified person in relation to the distribution for the purposes of Division 1A of former Part IIIAA of the ITAA 1936' is entitled to a franking credit or tax offset. Broadly speaking, to be a 'qualified person' in relation to the Dividend Component paid under the Buy-Back, the participating shareholder must satisfy both the holding period rule and the related payments rule.

Broadly, a shareholder will not satisfy the related payments rule if the shareholder, or associate of the shareholder, is under an obligation to make, or makes, a payment in respect of the dividend which effectively passes the benefit of the dividend to another person.

The holding period rule requires shareholders to hold the shares, or the interest in the shares, on which the dividend is paid at risk for a continuous period of at least 45 days. In determining whether a shareholder has satisfied the holding period rule, any days during which there is a materially diminished risk in relation to the relevant shares are not counted. The day of acquisition and the day of disposal of the relevant shares are also not counted.

Under subsection 160APHM(2) of the ITAA 1936, a shareholder is taken to have materially diminished the risks of loss and opportunities for gain with respect to shares or interests in shares if the 'net position' of the shareholder results in the shareholder having less than 30% of the risks and opportunities relating to the shares or interest in shares.

In this case the Commissioner does not regard the announcement of the Buy-Back offer as affecting whether the shares or an interest in shares were held at risk or not.

There are 45 clear days between 15 May 2007 and 30 June 2007, that is, the date the tender offer was accepted. Therefore, a shareholder who acquired shares on or before 15 May 2007 satisfies the holding period rule as long as those shares were held at risk for at least 45 continuous days. A shareholder who acquired shares after 15 May 2007 that were subsequently bought back under the Buy-Back is not a qualified person in relation to the dividend paid under the Buy-Back for the purposes of Division 1A of former Part IIIAA of the ITAA 1936.

Generally, under the holding period rule a shareholder will be deemed to have disposed of his or her most recently acquired shares first; subsection 160APHI(4) of the ITAA 1936. The 45 day rule operates on a last-in-first-out basis, so that shareholders will be deemed to have disposed of their most recently acquired shares first for the purposes of applying the 45 day rule. Accordingly, shareholders who, on or after 16 May 2007, acquired any additional Santos shares which conferred an entitlement to participate in the Buy-Back, may not qualify for the franking credits attached to the dividends paid on some or all of their shares sold into the Buy-Back.

Sections 45A and 45B of the ITAA 1936 are two anti-avoidance provisions which, if they apply, allow the Commissioner to make a determination that section 45C of the ITAA 1936 applies. The effect of such a determination is that all or part of the distribution of capital received by the shareholder under the Buy-Back is treated as an unfranked dividend. Accordingly, the application of these two provisions to the Buy-Back must be considered.

Section 45A of the ITAA 1936 is an anti-avoidance provision that applies in circumstances where capital benefits are streamed to certain shareholders (the advantaged shareholders) who derive a greater benefit from the receipt of share capital and it is reasonable to assume that the other shareholders (the disadvantaged shareholders) have received or will receive dividends.

Although a 'capital benefit' (as defined in paragraph 45A(3)(b) of the ITAA 1936) is provided to participating shareholders under the Buy-Back, the circumstances of the Buy-Back indicate that there is no streaming of capital benefits to some shareholders and dividends to other shareholders. Accordingly, section 45A has no application to the Buy-Back.

Section 45B of the ITAA 1936 applies where certain capital payments are paid to shareholders in substitution for dividends. In broad terms, section 45B applies where: (a) there is a scheme under which a person is provided with a capital benefit by a company (paragraph 45B(2)(a) of the ITAA 1936); (b) under the scheme, a taxpayer, who may or may not be the person provided with the capital benefit, obtains a tax benefit (paragraph 45B(2)(b) of the ITAA 1936); and (c) 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 a taxpayer to obtain a tax benefit (paragraph 45B(2)(c) of the ITAA 1936).

In the case of the Buy-Back, whilst the conditions of paragraphs 45B(2)(a) and 45B(2)(b) of the ITAA 1936 have been met, the requisite purpose of enabling the shareholder to obtain a tax benefit - by way of capital distribution - was not present.

Having regard to the 'relevant circumstances' of the scheme (the Buy-Back), as set out in subsection 45B(8) of the ITAA 1936, it is apparent that there was no requisite purpose, by way of capital distribution, of enabling the shareholders to obtain a tax benefit. Further, the Capital Component of the Buy-Back cannot be said to be attributable to the profits of the company, nor does the pattern of distributions that have been made by Santos in the past indicate that the Capital Component was being paid in substitution for a dividend.

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. In essence, it applies to schemes for the disposition of shares or an interest in shares, where a franked distribution is paid or payable in respect of the shares or an interest in shares. This would include a buy-back with a franked dividend component.

Specifically, subsection 177EA(3) of the ITAA 1936 provides that section 177EA 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.

In the present case the conditions of paragraphs 177EA(3)(a) to (d) of the ITAA 1936 are satisfied. Accordingly, the issue is whether, having regard to the relevant circumstances of the scheme, it would be concluded that, on the part of Santos, its shareholders or any other relevant party, there is more than merely an incidental purpose of conferring an imputation benefit under the scheme. Under this arrangement the relevant taxpayer is the participating shareholder and the scheme comprises the circumstances surrounding the Buy-Back.

In arriving at a conclusion the Commissioner must have regard to the relevant circumstances of the scheme which include, but are not limited to, the circumstances set out in subsection 177EA(17) of the ITAA 1936. The relevant circumstances listed there encompass a range of circumstances which taken individually or collectively could indicate the requisite purpose. Due to the diverse nature of these circumstances some may not be present at any one time in any one scheme.

The Commissioner has come to the view that section 177EA of the ITAA 1936 applies to the Buy-Back. In coming to this conclusion the Commissioner had regard to all the relevant circumstances of the arrangement, as outlined in subsection 177EA(17). Among the circumstances of the Buy-Back reflected in those paragraphs are: • 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; • 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 tax purposes, from their participation.

Where section 177EA of the ITAA 1936 applies the Commissioner has a discretion, pursuant to subsection 177EA(5) to make a determination to debit the company's franking account pursuant to paragraph 177EA(5)(a), or deny the imputation benefit to each shareholder pursuant to paragraph 177EA(5)(b). The Commissioner will exercise his discretion in such a way that he does not make a determination that the imputation benefit obtained by the participating shareholders be denied under paragraph 177EA(5)(b).

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 (paragraph 204-30(1)(a) of the ITAA 1997); (b) the member would derive a greater benefit from franking credits than another member of the entity (paragraph 204-30(1)(b) of the ITAA 1997); 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 (paragraph 204-30(1)(c) of the ITAA 1997).

Relevantly, if section 204-30 of the ITAA 1997 applies the Commissioner is vested with a discretion under subsection 204-30(3) to make a determination in writing either: (a) that a specified franking debit arises in the franking account of the entity, for a specified distribution or other benefit to a disadvantaged member (paragraph 204-30(3)(a) of the ITAA 1997); or (b) that no imputation benefit is to arise in respect of any streamed distributions made to a favoured member and specified in the determination (paragraph 204-30(3)(c) of the ITAA 1997).

For section 204-30 of the ITAA 1997 to apply, shareholders to whom distributions are streamed must derive a greater benefit from imputation benefits than the shareholders who did not participate in the Buy-Back. The words 'derives a greater benefit from franking credits' (imputation benefits) are defined in subsection 204-30(8) by reference to the ability of the shareholders to fully utilise imputation benefits.

A significant portion of Santos shareholding was held by non-residents who do not fully benefit from franking, a feature of the Buy-Back, to the same extent as resident shareholders. Thus, the conditions in subsection 204-30(1) of the ITAA 1997 for the provision to apply are met. However, the Commissioner will not make a determination under section 204-30.

The following is a detailed contents list for this Ruling: Paragraph What this Ruling is about 1 Relevant provision(s) 2 Class of entities 3 Qualifications 4 Date of effect 8 Scheme 13 Ruling 29 The Dividend Component 29 Assessability of the Dividend Component and Tax Offset 32 Refundable tax offset 34 Non-resident shareholders 35 Sale Consideration 36 Shares held on capital account 38 Shares held on revenue account 40 Foreign resident shareholders 41 Qualified persons 42 The anti-avoidance provisions 45 Appendix 1 - Explanation 48 The dividend and capital components 48 The Dividend Component 49 Assessability of the Dividend Component and the Tax Offset 50 Refundable tax offset 54 Non-resident shareholders 55 Sale Consideration 56 Foreign resident shareholders 63 Qualified person 67 The anti-avoidance provisions 74 Sections 45A and 45B 74 Section 177EA 80 Section 204-30 86 Appendix 2 - Detailed contents list 90