By Campbell Rose, Alex Mitchell, Greg Mitchell & Anna Roche
In April Inland Revenue issued the draft interpretation statement PUB00469: Income Tax – Whether an off-market share cancellation is made in lieu of the payment of a dividend (the IS). The IS considers the anti-avoidance rule in s CD 22(6) and (7) of the Income Tax Act 2007 (the Act) (called the “in lieu of dividend test”) and how it applies to an amount a company pays to a shareholder in an off-market cancellation of shares. It replaces IS 2966: Exclusion from the term “Dividends” – whether distribution made in lieu of dividends’ payment, which was published back in 1999.
How do these rules currently apply?
On the face of it, all distributions from a company to its shareholders in their capacity as shareholder are dividends, unless a dividend exclusion provision applies. This includes any amount distributed on the cancellation of shares in a company. However, an amount distributed on an off-market cancellation of shares may be excluded from the dividend definition where the relevant requirements in s CD 22 are satisfied. Broadly, the dividend exclusion applies objective “bright line tests” to determine when a company is undertaking a genuine capital reduction through a share cancellation, and these tests are buttressed by an anti-avoidance rule. The anti-avoidance in-lieu of dividend test applies in circumstances where the purpose of a share cancellation is to avoid paying a (taxable) dividend (i.e., a dividend substitute).
In applying the anti-avoidance rule, the Commissioner is required to consider a number of factors, which are set out in s CD 22(7). The factors are:
What’s new?
Off market share cancellations and in what circumstances the anti-avoidance provision applies has been a hot topic for Inland Revenue in recent years, with the boundary being closely scrutinised. Despite this, the draft IS does not propose wholesale changes to Inland Revenue’s views. Instead, the draft IS expands and clarifies the commentary in the original IS (more than doubling the length of the guidance). The notable updates include:
What does this mean?
The draft IS provides some welcome additional guidance on when a share cancellation may or may not be in lieu of a dividend. Although it is encouraging that the draft IS does not move the goal posts on the application of the anti-avoidance rule, it does highlight Inland Revenue’s view on the consequences for getting it wrong (by ‘tainting’ the entire share cancellation payment). What continues to be evident is that Inland Revenue expects that a share cancellation will be “supported by an objective and verifiable commercial purpose”, which is evident in the facts, both before and after the cancellation (e.g., dividend payment profile, changes to the business operations/ownership structure). Even with the commentary, this remains an area where the outcome can be 'grey' if the facts are not clear cut, and it is important to seek advice. In some situations, a binding ruling may be appropriate. This is an area that Inland Revenue is frequently asked to rule on, so this guidance reflects how the rules have been applied against binding ruling applications.
Inland Revenue has been increasingly focussed on disguised/substituted dividends (referred to as 'dividend avoidance'), and this updated guidance is further evidence that it is as important as ever to have your ducks in a row (and sufficiently documented), and potentially seeking certainty through a ruling, before undertaking a share cancellation.
The deadline for submissions on the draft guidance is 3 June 2025 and if you have any questions on the document or shares and dividends generally, please contact your usual Deloitte advisor.