The Full Federal Court in Cable & Wireless Australia & Pacific Holding BV (in liquidatie) v Commissioner of Taxation [2017] FCAFC 71 on May 1, 2017, unanimously held that a debit entry to a ‘buy-back reserve’ account did not record a transaction reducing a share capital account and accordingly, the return of those funds to shareholders was subject to dividend withholding tax (WHT).

The main issue in Cable & Wireless related to the characterisation for taxation purposes of an amount debited to the ‘buy-back reserve’ account as part of a share buyback transaction. The Full Federal Court held that whether an account is a share capital account does not necessarily turn on how that account is described. In Cable & Wireless, even though the ‘buy-back reserve’ account was debited, it represented the shortfall between the buy-back proceeds and the amount debited to the actual share capital account. This was because the buy-back consideration consisted both of a return of equity (the amount debited to the actual share capital account) and a return on equity (the amount debited to the buy-back reserve account). This was distinguished from the case of Commissioner of Taxation v Consolidated Media Holdings Ltd [2012] HCA 55 when the ‘share buy-back reserve’ account was held to be a share capital account because it only represented the return of equity. Therefore, it was held in Cable & Wireless that the amount debited to the ‘buy-back reserve’ was subject to dividend withholding tax (WHT) because it represented the shortfall amount which was the return on equity component.

PwC observation:

This decision highlights to entities involved in buy-back transactions with Australian entities that an emphasis should be placed on the proportion of funds used from the true share capital account for the buy-back. The mere classification of an accounting entry under the ‘share capital’ account would not suffice to be deemed a return of equity and instead could result in dividend WHT liabilities. More generally, it also reinforces a pre-existing approach by the Australian Taxation Office (ATO) that accounting entries in relation to dividend payments can have a material impact on their treatment for franking, WHT, and dividend participation exemption purposes.