Taxpayer unsuccessful in dispute over withholding tax on off-market share buy-back

In Cable & Wireless Australia & Pacific Holding BV (in liquidatie) v Commissioner of Taxation [2016] FCA 78, the taxpayer was unable to satisfy Justice Pagone that an amount paid to it as part of the consideration for the buy-back of shares it held in Cable & Wireless Optus Ltd (Optus) had been debited to Optus’ ‘share capital account’. As a result, the taxpayer was not entitled to request a refund of dividend withholding tax withheld from the buy-back consideration and paid to the Commissioner of Taxation. 

Briefly, in 2001 Optus was listed on the Australian Stock Exchange (ASX) and as at 18 May 2001, the taxpayer, Cable & Wireless Australia & Pacific Holding BV (in liquidatie) (CWA), a non-resident for Australian tax purposes, owned approximately 52 per cent of those shares, with the remaining shares being held by many other shareholders. 

In 1999, CWA had made the decision to dispose of its shareholding in Optus, and as part of the review process to implement that decision, CWA had prepared and distributed an information memorandum to parties that had expressed an interest in participating in the review. The culmination of the review was that the SingTel group emerged “as the only formal bidder for Optus”, and the agreement for the acquisition by the SingTel group of CWA’s shares in Optus included a proposal for all of the then existing Optus shareholders to be able to elect to have their Optus shares bought back in an ‘off-market’ share buy-back. Under the agreement, SingTel was required to fund the buy-back by the provision of finance to Optus. The buy-back was governed by the Implementation Agreement entered into and Division 2 of Part 2J.1 of the Corporations Act 2001.

On 6 September 2001, Optus bought back approximately 43 per cent of its shares for a total consideration of $6,225,502,632. At that time, Optus had $5,327,193,221 standing to the credit of its share capital account and debited $2,306,705,228 of the total consideration to that account. This debit was based on independent accounting advice to the effect that the appropriate amount of the buy-back consideration to debit to the share capital account was an amount determined by allocating to each share bought back, a pro-rata (based on number of shares on issue) of the share capital account balance at the time of the buy-back. The remaining $3,918,797,343 was debited to an account which was called the ‘buyback reserve account’. The part of the consideration paid to CWA that was debited to this account was treated at the time by all concerned (Optus, CWA and the Commissioner) as part of the dividend on which withholding tax was paid. 

Relying on the 2012 High Court decision in Commissioner of Taxation v Consolidated Media Holdings Ltd [2012] HCA 55 (Consolidated Media Holdings), CWA submitted to the Commissioner that the “buyback reserve account” was an account that Optus kept of its share capital, and that on this basis, dividend withholding tax paid to the Commissioner in 2001 had been paid in error. CWA accordingly made a request to the Commissioner that this amount be refunded. After the Commissioner disagreed with CWA’s view that the amount had been debited to a share capital account (and thus was not a dividend), CWA brought proceedings on this aspect of the matter to the Federal Court. 

The issue for determination by the Federal Court was whether the amount paid to CWA and debited to the ‘buyback reserve account’ had been debited to a ‘share capital account’ of Optus within the meaning set out by section 6D of the Income Tax Assessment Act 1936 (ITAA 1936) which applied at the time. The Commissioner’s position was that the amount in question had not been debited to such an account, with the result being that the amount was a dividend through the application of section 159GZZZP of the ITAA 1936, and that withholding tax was properly payable. 

In relation to the buy-back, and no doubt relying on what was said by the High Court in Consolidated Media Holdings, CWA submitted that since Optus had no positive equity reserves (other than share capital), and no retained profits, the financial position of Optus in relation to its share capital could only be understood by subtracting the debit balance in its buy-back reserve account from the credit balance in its shareholders’ capital account. On this basis, CWA submitted that the ‘buyback reserve account’ was a share capital account according to the definition in section 6D. 

This submission was rejected by Justice Pagone who, after distinguishing the facts from those in Consolidated Media Holdings said that “The fact that an outgoing has an impact upon a company’s equity does not stamp upon the outgoing the character of a reduction in capital. The comparison of the accounts considered by the High Court in Consolidated Media at [46] revealed a reduction of the capital available to Crown, but a comparison of the accounts of Optus showed that the share buy-back transaction had an impact upon equity in the company rather than any reduction of capital.” His Honour went on to say that “Optus used its assets as consideration for the buy-back which in this case was sourced from loans governed by the Implementation Agreement. Optus was able to make the buy-back from its assets regardless of whether it had available profits, an asset revaluation reserve or any other positive equity account.” 

In determining that Optus did not debit a share capital account when it debited the ‘buyback reserve account’ with $3,918,797,343, Justice Pagone identified that the source of the funding was not from existing capital, but rather, was from funds that were required to be provided (and were so provided) to Optus by the SingTel group. Relevantly, his Honour said that “The consideration debited to the share buy-back reserve account came from borrowings pursuant to an agreement for the funding of a takeover in which the buyback was a component. .The Optus buy-back reserve account, unlike that considered in Consolidated Media, was not a record of a transaction reducing the share capital of the company. The Optus buy-back reserve account was needed to account for the payment of part of the consideration paid for the shares bought back from money lent to Optus by SingTel for that purpose.” 

Justice Pagone also considered the subsequent issue of 1,643,098,304 shares to SingTel for an amount of $6,229,387,472.78, with this amount being credited on 31 October 2001 to an account in the ledger of Optus labelled ‘share capital’. A corresponding debit of that amount was made to the ‘subordinated debt’ account in the ledger which recorded the funds provided by the SingTel group to implement the September 2001 share buy-back. With respect to this, CWA had submitted that “The precise correspondence between the total buy-back consideration paid by Optus, and the share capital subscribed by SingTel confirms that Optus raised new share capital to replace share capital paid out by it to shareholders who chose the buy-back alternative pursuant to the takeover offer”. Justice Pagone rejected this submission stating that the share issue was a subsequent transaction to the buy-back and that the “journal entries thus confirmed the source of the previous payment to the applicant as being from the moneys borrowed by Optus for the payment and not from amounts which had been contributed as capital”. 

Clearly the decision in favour of the Commissioner places weight on the source of the funds used to implement the buy-back. It is this aspect of the decision that will need to be carefully considered by companies entering into off-market share buyback transactions.