Income Tax Assessment Act 1997 - section 200-20 - Division 207 - Part 3-1 - Part 3-3 - section 975-300(1) - section 975-300(2)

Corporations Act 2001 - section 257A

Taxation Administration Act 1953 - Division 340 of Schedule 1

1. Mrs Fitzgerald seeks a review of the Commissioner's decision, dated 15 March 2011, to disallow her objection to the amended assessment issued to her in respect of the income year ended 30 June 2009, which assessment included in her assessable income for that income year an amount of $451,600 for unfranked dividends received from a selective off-market buy-back of her shares in Edgecombe Bros Pty Ltd (Edgecombe) and which was issued by the Commissioner in accordance with an amended tax return lodged by Mrs Fitzgerald for the that income year.
2. In particular, Mrs Fitzgerald asserts that the Commissioner's amended assessment was excessive.

WAS THE AMOUNT OF $451,600, THAT WAS DISCLOSED AS AN UNFRANKED DIVIDEND IN MRS FITZGERALD'S AMENDED INCOME TAX RETURN FOR THE YEAR ENDED 30 JUNE 2009, PROPERLY INCLUDED IN HER ASSESSABLE INCOME FOR THAT YEAR?

1. The tax consequences of a share "buy-back" are set out in Division 16K of Part III of the Income Tax Assessment Act 1936 (ITAA 1936), comprising sections 159GZZZJ to 159GZZZS of the ITAA 1936 and, in short, depend on whether the "buy-back" concerned is "on-market" or "off-market". Where a company buys back shares in itself from a shareholder in the company, the purchase is a "buy-back" and the relevant shareholder is the 'seller' of those shares for Division 16K purposes: section 159GZZZK of the ITAA 1936.
2. An "on-market" buy-back happens if the share is listed on a stock exchange and the buy-back is made in the ordinary course of the business of the stock exchange, except if the transaction is described as 'special' under the stock exchange rules: section 159GZZZK(c) of the ITAA 1936. Any other buy-back is an "off-market" buy-back: section 159GZZZK(d) of the ITA 1936.
3. For an "off-market" buy-back, the difference between the "purchase price" and that part of the "purchase price" that is debited against amounts standing to the credit of the "company's share capital account" is treated as a 'dividend' paid to the shareholder out of company profits on the day of the buy-back: section 159GZZZP(1) of the ITAA 1936. The deemed 'dividend' is included in the assessable income of the shareholder under section 44(1) of the ITAA 1936.
4. "Purchase price" is described, in section 159GZZZM of the ITAA 1936, as meaning:
   • The amount of money, or the sum of the amounts of money, a seller receives, or is "entitled to receive", as a result of or in respect of a buy-back (paragraph (a)); or
   • The market value at the time of the buy-back of any property (other than money) a seller receives, or is "entitled to receive", as a result of or in respect of a buy-back (paragraph (b)); or
   • If the seller has received, or is "entitled to receive", both money and property (other than money) as a result of or in respect of the buy-back, the sum of that amount of money and the market value of the property at the time of the buy-back (paragraph (c)).
5. The expression "company's share capital account" (as it appears in 159GZZZP of the ITAA 1936) is defined section 975-300(1) of the Income Tax Assessment Act 1997 (ITAA 1997) as simply "an account where a company keeps its share capital". Section 975-300(2) of the ITAA 1997 provides that if a company has more than one share capital account, the accounts are taken for the purposes of the ITAA 1997 to be a single account.
6. An essential part of any off-market buy-back is the "split" (if any) between the return of capital and dividend paid to the participating shareholders. The "split" is ordinarily nominated by the company conducting the share buy-back. The "average capital per share" methodology is generally preferred by the Commissioner for determining the dividend/capital split in an off-market share buy-back: see Practice Statement PS LA 2007/9. This method entails simply dividing the total amount standing to the share capital account by the total number of issued shares.
7. For general income tax and capital gains tax (CGT) purposes, the disposal consideration for the share is the buy-back price: section 159GZZZQ of the ITAA 1936. To prevent the deemed dividend resulting in double taxation, a reduction applies in determining the revenue gain or loss (if any) on the sale of the shares. That is, the buy-back price is reduced by so much of the dividend as is: (a) included in the shareholder's assessable income; or (b) an eligible non-capital amount (i.e. an amount not debited or attributable to a share capital account or an asset revaluation reserve: section 159GZZZQ(4) of the ITAA 1936.

1. Edgecombe is a company incorporated in Western Australia. No shares issued by Edgecombe have ever been listed for quotation in the official list of a stock exchange in Australia or elsewhere.
2. In February 2008 Edgecombe made an offer, pursuant to section 257A of Part 2J.1 of the Corporations Act 2001, for the selective buy-back the all of the shares held by Mrs Fitzgerald (and six other shareholders) in the company for $93.25 per share, less amounts unpaid on any partly paid shares. Edgecombe's buy-back offer remained open until 1 August 2008.
3. According to Edgecombe's Balance Sheet, as at 30 June 2008, the company had Total Equity of $1,569,977, comprising:

Accumulated losses during year ended 30 June 2008 -$19,969

1. According to Edgecombe's offer document, Edgecombe proposed to fund the buy-back from:
   • (a) the sale of Lot 1 on Plan 4613, being the whole of the land comprised in Certificate of Title Volume 1889 Folio 51; and
   • (b) Edgecombe borrowing the amount of $1,100,000 from Westpac Banking Corporation, secured by first registered mortgages over the land owned by Edgecombe (other than Lot 1 on Plan 4613).
2. Before the buy-back, Mrs Fitzgerald held the following shares in Edgecombe:
   • (a) 449 $2 fully paid "A" Class shares; and
   • (b) 5000 $2 "E" class shares, that were not fully paid;

Thus, Mrs Fitzgerald held a total of 5,449 shares in Edgecombe before the buy-back. Those shares were issued to Mrs Fitzgerald at par value. It is common ground that Mrs Fitzgerald acquired all of her shares in Edgecombe before 20 September 1985 such that the sale of her shares does not have any CGT consequences.

1. Mrs Fitzgerald accepted Edgecombe's offer in August 2008.
2. Edgecombe conducted the share buy-back on 23 August 2008.
3. In an e-mail to the Australian Taxation Office (ATO) on 4 November 2011, Edgecombe's accountants, Ruthven Gangemi, stated:

"1. According to my information, Elisabeth Fitzgerald disposed of 449 A class shares for $93.25 and 5000 E class shares for $92.22, total consideration was $502,969.25;

3. According to my records, the total amount paid up for the 5449 shares was $15,805.03;

6......it appears that $15,805.03 was debited against [Edgecombe's] share capital and share premium reserve. The remaining portion of the payment was entered into an account we created called "2009 Share Buy Back" in the equity section of the balance sheet. As we were still investigating the correct way to treat the payment, the debit was put to this account" [Emphasis added]

1. According to Ruthven Gangemi, they used the "average capital per share" method (described at paragraph 62 of PS LA 2007/9) to calculate the amount of $15,805.03 that they debited to Edgecombe's share capital account. The Commissioner provided the Tribunal with his own calculation which suggests a lesser amount. Despite this, the Commissioner stated that he was prepared to accept the figure of $15,805.03 as correct.
2. In a subsequent e-mail to the ATO (dated 7 November 2011), Ruthven Gangemi said:

".....it appears a cheque for $499,819.25 was paid to Elisabeth Fitzgerald on 25/8/08. This is $3,145.75 less than we thought she should have received. I can't explain why this happened, however I will ask the directors to review the payments." [Emphasis added]

Mrs Fitzgerald told the Tribunal that she cannot recall the exact amount of money that received for the buy-back of her shares in Edgecombe and that the enquiries she had made with her bank to determine what she was paid, had been unsuccessful.

1. On 9 November 2009 an income tax return was lodged on behalf of Mrs Fitzgerald, by her tax agent, H & R Block, in respect of the income year ended 30 June 2009 that disclosed a taxable income of $41,489. That return did not disclose any proceeds from the buy-back of Mrs Fitzgerald's shares in Edgecombe. On 16 November 2009 the respondent issued an income tax assessment to the applicant in respect of the year ended 30 June 2009 in accordance with that income tax return.
2. On 8 April 2010 an amended income tax return was lodged on behalf of the applicant, by her tax agent, H & R Block, in respect of the year ended 30 June 2009. That income tax return included the following items not disclosed or claimed in Mrs Fitzgerald's original income tax return for that income year:
   • (a) "unfranked dividends" of $451,600 relating to Mrs Fitzgerald's entitlement to the proceeds from the buy-back of her shares in Edgecombe in August of 2008; and

(b) a claimed deduction of $11,936 for expenses relating to Mrs Fitzgerald's share of legal fees incurred in relation to the buy back;

and, on that basis, disclosed an amended taxable income totalling $480,953. This resulted in a tax shortfall amount of $194,967.51, which Mrs Fitzgerald has paid in full.

1. On 17 May 2010 the Commissioner issued an amended assessment to Mrs Fitzgerald in respect of the year ended 30 June 2009 in accordance with the said amended income tax return. The Commissioner treated a letter sent by Mrs Fitzgerald to him, dated 2 November 2010, as an objection to that amended assessment. The Commissioner disallowed that objection, by notice dated 15 March 2011.
2. There was evidence that Mrs Fitzgerald's cousin, Mr John F Edgecombe, also participated in the buy-back and that before accepting the buy-back offer sought a private binding ruling from the Commissioner on the question whether the proceeds from the buy-back of his shares in Edgecombe would constitute assessable income. In conclusion, Mr Edgecombe's Notice of Private Ruling, dated 3 December 2009 stated:

"Your assessable income for the 2008-09 income year should include the unfranked dividend of $418,091.07 that you received for the buy-back (section 44 of the ITAA 1936) and a capital loss of $1,035.03 (section 104-10(4) of the ITAA 1997)."

1. Although it is not clear on the evidence, it was suggested that it was the outcome of Mr Edgecombe's Private Ruling which prompted Mrs Fitzgerald's tax agent, H & R Block, to prepare and file an amended tax return for her for the year ended 30 June 2009 to include in her assessable income for that year an amount for the "unfranked dividends" received by her from Edgecombe for the buy-back of her shares.
2. As stated above, Mrs Fitzgerald's amended tax return indicated that she received $451,600 in "unfranked dividends" as a result of the August 2008 share buy-back. However, according to Edgecombe's accountants she received a cheque for $499,819.25 from Edgecombe for the buy-back of her shares. Although, she was "entitled to receive", in terms of section 159GZZZM of the ITAA 1936, $502,119.25 as consideration for the buy-back of her shares, calculated as follows - $93.25 per share X 5,449 shares = $508,119.25, less unpaid amounts on her "E" class (partly paid) shares.
3. Edgecombe's Balance Sheet, as at 30 June 2009, provides that the company had Total Equity of $2,683,395, comprising:

1. There is no evidence that Edgecombe allocated a franking credit to any part of the purchase price it agreed to pay Mrs Fitzgerald for her shares.

1. The transaction whereby Edgecombe purchased from Mrs Fitzgerald the 5,449 shares she held in Edgecombe was a "buy-back" (as defined in section 159GZZZK of the ITAA 1936) for the purposes of Division 16K of Part III of the ITAA 1936.
2. That buy-back was an "off-market" buy-back for Division 16K purposes because Mrs Fitzgerald's shares in Edgecombe were indisputably not listed for quotation in the official list of a stock exchange in Australia or elsewhere: sections 159GZZZJ and 159GZZZK(c) and (d) of the ITAA 1936.
3. The "purchase price" was an amount equal to the product of 5,449 (being the number of shares sold by Mrs Fitzgerald to Edgecombe - i.e. 449 "A" class and 5000 "E" class) and the amount paid per share ($93.25), less any amounts unpaid on Mrs Fitzgerald's "E" class (partly-paid) shares: section 159GZZZM of ITAA 1936.
4. As the buy-back was an "off-market" buy-back (purchase), section 159GZZZP of ITAA 1936 applies. Section 159GZZZP(1) of ITAA 1936 deems the difference between the "purchase price" in respect of the said buy back and the part, if any, of the "purchase price" in respect the buy-back of the share which is debited against amounts standing to the credit of Edgecombe's "share capital account" to be a "dividend" paid by the company:
   • (a) to Mrs Fitzgerald (the seller) as a shareholder in Edgecombe;
   • (b) out of profits derived by Edgecombe;
   • (c) on the day the buy-back occurred.

1. Pursuant to section 44 of ITAA 1936, that deemed dividend is assessable income of Mrs Fitzgerald (the seller) for the year ended 30 June 2009 (being the income year in which the buy-back occurred).
2. As mentioned above, according to Edgecombe's accountants, Ruthven Gangemi, $15,805.03 was debited by Edgecombe against its share capital account (including its share premium reserve) in respect of the buy-back of Mrs Fitzgerald's shares. The difficulty in the present case is that the evidence suggests that Mrs Fitzgerald was "entitled to receive", in terms of what is meant by "purchase price" in section 159GZZZM of the ITAA 1936, the higher amount of $502,969.25, as consideration for the buy-back of her shares. This is calculated as $93.25 per share X 5,449 shares = $508,119.25, less unpaid amounts on her "E" class shares (after taking into account the effective reduced price of $92.22 per share for her "E" class shares). However, Mrs Fitzgerald's amended tax return for the income year ended 30 June 2009 disclosed the lesser amount of $451,600 as consideration for the buy-back of her shares. Since Mrs Fitzgerald was assessed on only $451,600, and cannot explain why her tax agent, H & R Block, had adopted that figure on her behalf, even if a deduction of $15,805.03 is allowed for the capital component of her "purchase price", the resulting net deemed dividend of $487,164.22 (being $502,969.25 less $15,805.03) still exceeds $451,600, i.e. the amount on which she was assessed by the Commissioner. In such circumstances, her assessment for the year ended 30 June 2009 cannot be said to be "excessive". The position is the same even if one adopts (leaving aside section 159GZZZM of the ITAA 1936) a "purchase price" of $499,819.25, being the amount Mrs Fitzgerald was, according to Ruthven Gangemi, actually paid by cheque in respect of the buy-back on 25 August 2008.
3. The "deemed dividend" that arises under section 159GZZZP of the ITAA 1936 is a frankable dividend that is capable of being "franked" pursuant to section 200-20 of ITAA 97. That is, by the relevant company allocating a franking credit to all or any part of the deemed dividend. This entitles the recipient of the dividend to a tax offset (i.e. an imputation credit) in respect of the dividend, pursuant to Division 207 of the ITAA 1997. However, in this case, there is no evidence that Edgecombe allocated a franking credit to all or any part of Mrs Fitzgerald's deemed dividend and the amount of $451,600 which was included in her amended tax return for the year ended 30 June 2009 was described as an "unfranked dividend". Consequently, Mrs Fitzgerald is not entitled to any tax offset (imputation credit), pursuant to Division 207 of the ITAA 1997, in respect of that deemed dividend.
4. The remainder of the sale consideration (i.e. the part debited by the company against its "share capital account" and not treated as a deemed dividend) is treated as a capital receipt for the purposes of the CGT provisions in Part 3-1 and 3-3 of the ITAA 1997 and in determining whether a capital gain or loss has been made by the shareholder in relation to the sale. As discussed above, it is not in dispute that Mrs Fitzgerald acquired all of her shares ("A" and "E" class) in Edgecombe before 20 September 1985 and the introduction of the CGT provisions. That is, they are pre-CGT shares. Consequently, Mrs Fitzgerald has no assessable capital gain in respect of that part of the sale consideration (i.e. $15,808.25). Further, the sale of her shares in Edgecombe cannot give rise to a capital loss.
5. Accordingly, the amended assessment for the year ended 30 June 2009 that was issued by the Commissioner to Mrs Fitzgerald is not excessive and the amount of $451,600 was properly included in her assessable income for that income year.

1. Mrs Fitzgerald told the Tribunal that she considered the proceeds from the sale of her shares in Edgecombe as her "inheritance" and that she was relying on that money to support her in her retirement, but that she had now lost so much of that inheritance ($194,967.51) in tax. Mrs Fitzgerald stated that she had been a single parent since 1976 and had always really struggled financially. She said that she has 4 children and 20 grandchildren which she helps and that she had taken in her sick mother and cared for her until she died. Mrs Fitzgerald said that she didn't expect that there would be no tax payable on the sale of her shares in Edgecombe, just not so much. She asked that the taxation laws be applied more leniently, and not so harshly, in her particular circumstances.
2. Unfortunately for Mrs Fitzgerald, the Tribunal's jurisdiction extends only to applying the law as it is written by the legislature. It is unable to apply the taxation legislation differently to different taxpayers.
3. Where payment of tax would entail "serious hardship", a taxpayer may apply for release from payment of the liability, in whole or in part. The Commissioner has sole authority for determining applications for release: Division 340 of Schedule 1 of the Taxation Administration Act 1953 (TAA). The decision to grant relief is based on whether payment of the liability would cause the taxpayer to suffer "serious hardship". A taxpayer who is dissatisfied with the Commissioner's decision on hardship has a right to object under Part IVC of the TAA and then, if that objection is disallowed, to apply to this Tribunal for a review of that objection decision. Guidelines on determining whether "serious hardship" exists in a particular case can be found in Chapter 24 of the ATO Receivables Policy. According to that policy, "serous hardship" would exist where a taxpayer is left without the means to achieve reasonable acquisitions of food, medical supplies, accommodation, education for children and other basic requirements. The difficulty in Mrs Fitzgerald's case is that she has already paid the tax assessed (i.e. $194,967.51) in full.

1. For the above reasons, the Tribunal affirms the decision under review, being the Commissioner's objection decision dated 15 March 2011.

I certify that the 40 preceding paragraphs are a true copy of the reasons for the decision herein of Senior Member C Walsh

Representative for the Applicant Mrs Fitzgerald (Self-represented)