Income tax: Monash Absolute Investment Company Limited - off-market share buy-back

This Ruling sets out the Commissioner's opinion on the way in which the relevant provisions 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 Ruling are: • section 45A of the Income Tax Assessment Act 1936 (ITAA 1936) • section 45B of the ITAA 1936 • section 159GZZZK of the ITAA 1936 • section 159GZZZP of the ITAA 1936 • section 159GZZZQ of the ITAA 1936 • section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997) • section 8-1 of the ITAA 1997 • section 104-10 of the ITAA 1997 • section 106-5 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. All legislative references in this Ruling are to the ITAA 1936 unless otherwise indicated.

The class of entities to which this Ruling applies is the ordinary shareholders of Monash Absolute Investment Company Limited (MA1) who: • disposed of their ordinary shares in MA1 held at the Record date of 3 August 2018 under the MA1 off-market share buy-back (the Buy-Back) which was announced by MA1 on 20 June 2018 and which is described in the Scheme section of this Ruling, and • are not subject to the taxation of financial arrangement rules in Division 230 of the ITAA 1997 in relation to gains and losses on their ordinary shares in MA1. ( Note: Division 230 of the ITAA 1997 will generally not apply to individuals, unless they have made an election for the Division to apply to them.) In this Ruling, a person belonging to this class of entities is referred to as a 'Participating Shareholder'. The simultaneous share purchase plan also announced by MA1 on 20 June 2018 is not considered 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 8 to 22 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because the scheme entered into is not the scheme on which the Commissioner has ruled, and • this Ruling may be withdrawn or modified.

This Ruling applies from 1 July 2018 to 30 June 2019. The Ruling continues to apply to all entities within the specified class who entered into the specified scheme during the term of the Ruling.

However, this Ruling will not apply to taxpayers to the extent that it conflicts with the terms of a settlement of a dispute agreed to before the date of issue of this Ruling (see paragraphs 75 and 76 of Taxation Ruling TR 2006/10 Public Rulings ).

The following description of the scheme is based on information provided by the Applicant. Note: Certain information has been provided on a commercial-in-confidence basis and will not be disclosed or released under Freedom of Information legislation.

Monash Absolute Investment Company Limited (MA1) is an Australian public company incorporated in 2016.

MA1's ordinary shares (being its only class of share) were listed on the Australian Securities Exchange (ASX) on 12 April 2016.

As at 30 June 2018 MA1 had 49,223,436 ordinary shares on issue. As at 30 June 2018 MA1 had issued and paid up share capital of $48,454,318.

MA1's ordinary shareholders are a mix of individuals, companies, trusts, partnerships and superannuation funds.

As at 30 June 2018, less than 1% of MA1's ordinary shares are held by non-resident shareholders.

MA1 did not pay any dividends in relation to the years ended 30 June 2016 or 30 June 2017. On 31 October 2018, MA1 paid a fully franked dividend of 1 cent per ordinary share franked at 27.5% in relation to the year ended 30 June 2018.

As at 30 June 2018 MA1 had retained losses of $7,319,145 and a profit reserve of $8,094,292.

On 20 June 2018, MA1 announced its intention to undertake a capital-only off-market share buy-back of up to 10% of its ordinary issued share capital (that is, up to 4,922,341 ordinary shares) with the Buy-Back Price to be set at a 5% discount to the pre-tax Net Tangible Asset Backing per share.

On 20 June 2018, MA1 also announced an opportunity for shareholders to participate in a share purchase plan. As mentioned at paragraph 3 of this Ruling, the share purchase plan is not considered in this Ruling.

Shareholders registered on the record date, being 3 August 2018, were able to participate in the off-market share buy-back. The Buy-Back was conducted through an off-market tender.

On 4 September 2018, MA1 announced that the Buy-Back Price was $0.96 per MA1 share.

On 12 September 2018, MA1 announced the completion of the Buy-Back and that MA1 bought back 4,922,341 shares (10% of MA1's issued share capital) for a total consideration of $4,725,447.

All shares were bought back and cancelled on 12 September 2018 thereby reducing the number of MA1 shares on issue.

MA1's share capital account (as defined in section 975-300 of the ITAA 1997) was not tainted for the purposes of section 197-50 of the ITAA 1997.

For the purposes of Division 16K, the Buy-Back is an off-market purchase within the meaning given by paragraph 159GZZZK(d).

No part of the proceeds received by Participating Shareholders as a result of the Buy-Back is a dividend under subsection 159GZZZP(1) or under subsection 6(1).

A Participating Shareholder is taken to have received $0.96 per share as consideration (Sale Consideration) in respect of each share bought back under the Buy-Back on 12 September 2018 in accordance with section 159GZZZQ.

The treatment of the Sale Consideration for tax purposes will depend on whether a Participating Shareholder held the sold shares on capital account (where the shares are held for investment) or on revenue account (as trading stock or revenue assets other than trading stock).

The shares are taken to have been disposed of for CGT purposes on 12 September 2018 pursuant to section 104-10 of the ITAA 1997 (CGT event A1).

The Sale Consideration of $0.96 per share is the capital proceeds for CGT purposes pursuant to section 116-20 of the ITAA 1997.

A Participating Shareholder (other than a partnership) makes a capital gain on a share if the Sale Consideration exceeds the cost base of the share. The capital gain is the amount of the excess. Similarly, a Participating Shareholder (other than a partnership) makes a capital loss on a share if the Sale Consideration per share is less than the reduced cost base of the share (subsection 104-10(4) of the ITAA 1997).

Each partner in a partnership has a separate Cost base / reduced cost base for the partner's interest in each share sold into the Buy-Back by the partnership (subsection 106-5(2) of the ITAA 1997). Each partner is allocated an appropriate share of the Sale Consideration received by the partnership for the disposal of shares into the Buy-Back.

Where shares were held as trading stock the Sale Consideration of $0.96 per share is included in a Participating Shareholder's assessable income pursuant to section 6-5 of the ITAA 1997. A Participating Shareholder (other than a partnership) who held shares as trading stock also makes a capital gain or capital loss calculated as discussed at paragraph 29 of this Ruling. However, any capital gain or capital loss made is disregarded if at the time of the CGT event the shares were held by a Participating Shareholder as trading stock (subsection 118-25(1) of the ITAA 1997). There is a similar exemption for partners in partnerships (paragraph 118-25(1)(b) of the ITAA 1997).

Where shares were held as revenue assets, but were not held as trading stock, the amount by which the Sale Consideration of $0.96 per share exceeds the cost of the share is included in a Participating Shareholder's assessable income under section 6-5 of the ITAA 1997. Correspondingly, if the cost of each share exceeds the Sale Consideration per share the difference is an allowable deduction under section 8-1 of the ITAA 1997. Where the Sale Consideration per share exceeds the cost base of the share, the Participating Shareholder (other than a partnership) will also make a capital gain. However any capital gain the Participating Shareholders made is reduced if, because of the disposal, an amount has otherwise been included in assessable income (subsection 118-20 of the ITAA 1997). The capital gain is reduced to zero if the capital gain does not exceed the amount otherwise included in assessable income (subsection 118-20(2) of the ITAA 1997). If the capital gain exceeds the amount otherwise included in assessable income, the capital gain is reduced by the amount otherwise included in assessable income (subsection 118-20(3) of the ITAA 1997). There is a similar reduction for partners in partnerships (paragraphs 118-20(1)(b) and 118-20(2)(b), and subsection 118-20(3) of the ITAA 1997).

The Commissioner will not make a determination under subsections 45A(2) or 45B(3) that section 45C applies to the whole or any part of the Sale Consideration received by a Participating Shareholder.

For the purposes of Division 16K where a company buys a share in itself from a shareholder the purchase is a 'buy-back' (paragraph 159GZZZK(a)).

Division 16K categorises a buy-back as either an 'on-market purchase' or an 'off-market purchase'.

A buy-back is an on-market purchase if the share bought back is listed for quotation in the official list of a stock exchange in Australia or elsewhere, and the buy-back is made in the ordinary course of trading on that stock exchange (paragraph 159GZZZK(c)). A buy-back that is not an on-market purchase is an off-market purchase (paragraph 159GZZZK(d)).

Although MA1's ordinary shares are listed for quotation in the official list of the ASX, the Buy-Back was not made in the ordinary course of trading on the ASX. As a result, for the purposes of Division 16K, the Buy-Back is an off-market purchase within the meaning given by paragraph 159GZZZK(d).

The Buy-Back Price was debited entirely against MA1's share capital account. Therefore, no part of the Buy Back Price is taken to be a dividend for income tax purposes under section 159GZZZP.

Subsection 44(1) includes in a shareholder's assessable income any dividends, as defined in subsection 6(1) of the ITAA 1997, paid to the shareholders out of profits derived by the company from any source (if the shareholder is a resident of Australia) and from an Australian source (if the shareholder is a non-resident of Australia).

The term 'dividend' is defined in subsection 6(1) of the ITAA 1997 and includes any distribution made by a company to any of its shareholders. However, paragraph (d) of the definition of 'dividend' excludes a distribution from the meaning of 'dividend' if the amount of the distribution is debited against an amount standing to the credit of the company's share capital.

The term 'share capital account' is defined in section 975-300 of the ITAA 1997 as an account which the company keeps of its share capital, or any other account created on or after 1 July 1998 where the first amount credited to the account was an amount of share capital. However, if the company's share capital account is tainted, within the meaning given in section 197-50 of the ITAA 1997, that account is taken not to be a share capital account (subsection 975-300(2) of the ITAA 1997).

In this case, the distribution was recorded as a debit to MA1's untainted share capital account.

Paragraph (d) of the definition of 'dividend' in subsection 6(1) will apply. Accordingly, no part of the Buy Back Price is a dividend, as defined in subsection 6(1) of the ITAA 1997.

For the purpose of computing the amount of the gain or loss (on capital or revenue account) for tax purposes on the sale of shares under the Buy-Back, the consideration in respect of the disposal of a share under an off-market share buy-back is determined in accordance with section 159GZZZQ.

Pursuant to subsection 159GZZZQ(1) a Participating Shareholder is taken to have received an amount equal to the purchase price (in this case the $0.96 received for each share bought back) as consideration in respect of the share bought back.

The Buy-Back Price was calculated by applying a 5% discount to the pre-tax Net Tangible Asset Backing per share on 31 August 2018. As the Commissioner accepts that the purchase price of $0.96 of an MA1 share in this buy-back was not less than the market value of the share, subsection 159GZZZQ(2) does not apply to deem an increased sale consideration for tax purposes.

Participating Shareholders are taken to have disposed of their shares accepted under the Buy-Back on 12 September 2018. 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 CGT provisions, and • a share trader who held their shares on revenue account will be subject to the ordinary income provisions.

CGT event A1 happened when a Participating Shareholder disposed of MA1 shares under the Buy-Back (section 104-10 of the ITAA 1997).

The time of the CGT event A1 was the date on which the Buy-Back was completed. This occurred on 12 September 2018.

The Sale Consideration of $0.96 per share represents the capital proceeds for CGT purposes pursuant to subsection 116-20(1) of the ITAA 1997.

A Participating Shareholder (other than a partnership) will make a capital gain in respect of the disposal of a share if the Sale Consideration per MA1 share exceeds the cost base of the share. The capital gain is the amount of the excess. Similarly, a Participating Shareholder (other than a partnership) will make a capital loss in respect of the disposal of a MA1 share if the Sale Consideration per share is less than the reduced cost base of the share (subsection 104-10(4) of the ITAA 1997).

Where the Participating shareholder is a partnership, any capital gain or loss will be made by the partners individually (subsection 106-5(1) of the ITAA 1997). Each partner in a partnership has a separate Cost base / reduced cost base for the partner's interest in each share sold into the Buy-Back by the partnership (subsection 106-5(2) of the ITAA 1997). Each partner is allocated an appropriate share of the Sale Consideration received by the partnership for the disposal of shares into the Buy-Back.

Where shares were held as trading stock, the Sale Consideration of $0.96 per share is included in assessable income under section 6-5 of the ITAA 1997. Participating Shareholders (other than partnerships) who disposed of shares held as trading stock will also make a capital gain or capital loss. However, as the shares were held as trading stock, the capital gain or loss is disregarded pursuant to section 118-25 of the ITAA 1997. There is a similar exemption for partners in partnerships (paragraph 118-25(1)(b) of the ITAA 1997).

Where shares were held as revenue assets, but were not trading stock, the amount by which the Sale Consideration of $0.96 per share exceeds the cost of each share is included in assessable income. Correspondingly, if the cost exceeds the Sale Consideration of $0.96 per share, the difference is an allowable deduction. Where the Sale Consideration per share exceeds the cost base of the share these Participating Shareholders (other than partnerships) will also make a capital gain. However, Participating Shareholders who held their shares as revenue assets other than as trading stock will have the amount of the capital gain reduced under the CGT anti-overlap provisions contained in section 118-20 of the ITAA 1997. There is a similar reduction for partners in partnerships (paragraphs 118- 20(1)(b) and 118-20(2)(b), and subsection 118-20(3) of the ITAA 1997).

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

Section 45A 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)) 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. Under the Buy-Back, all Participating Shareholders received a distribution of share capital based on the number of shares they sold into the Buy-Back. Accordingly, section 45A has no application to the Buy-Back.

Section 45B 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)) (b) under the scheme, a taxpayer (the 'relevant taxpayer'), who may or may not be the person provided with the capital benefit, obtains a tax benefit (paragraph 45B(2)(b)), 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 the relevant taxpayer to obtain a tax benefit (paragraph 45B(2)(c)).

While the conditions of paragraphs 45B(2)(a) and (b) were met in respect of the Buy-Back, the requisite purpose of enabling a person to obtain a tax benefit as a result of the capital distribution was not present.

Having regard to the 'relevant circumstances' (as set out in subsection 45B(8)) of the Buy-Back, it is apparent that: • the distribution of share capital of $0.96 per share could not be said to be attributable to the profits of MA1 • the pattern of distributions of MA1 did not indicate that the distribution of share capital of $0.96 per share was paid in substitution of a dividend, and • as a consequence of the Buy-Back, the distribution of share capital resulted in the cancellation of ordinary shares in MA1 held by Participating Shareholders and a corresponding loss of dividend, voting and other rights.

Accordingly, the Commissioner will not make a determination under subsection 45B(3) that section 45C applies to treat all or part of the distribution of share capital of $0.96 per share as an unfranked dividend paid by MA1.

The following is a detailed contents list for this Ruling: Paragraph Summary - what this Ruling is about 1 Relevant provisions 2 Class of entities 3 Qualifications 4 Date of effect 6 Scheme 8 The Share Buy-Back 16 Ruling 23 Off-market purchases 23 Distribution is not a dividend 24 Sale Consideration 25 Shares held on capital account 27 Shares held on revenue account 31 The anti-avoidance provisions 33 Appendix 1 - Explanation 34 Off-market purchases 34 Distribution is not a dividend 38 Sale Consideration 44 Shares held on capital account 48 Shares held on revenue account 53 The anti-avoidance provisions 55 Appendix 2 - Detailed contents list 62