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Authorisation Number: 1011571758418

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Ruling

Subject: Pre-CGT status of company assets - changes in majority underlying interests

Question 1

Have any of the changes in the underlying interests in the company's (the company) assets acquired prior to 20 September 1985 resulted in the assets losing their pre-CGT status under section 160ZZS of the Income Tax Assessment Act 1936 (ITAA 1936) or section 149-30 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

No

Relevant facts and circumstances

Immediately prior to 20 September 1985 the shareholders of the company were as follows:

Deceased estate 1 - A Class shares

X Trust - B Class shares

Person 1 - B Class share

Changes in the underlying interest in the Company assets since 20 September 1985

Addressed by this ruling, are the following changes in the underlying interests in the company assets acquired prior to 20 September 1985.

X Trust vested on a specific date.

· X Trust was a discretionary trust.

· The specified beneficiaries of X Trust were Person 1, Person 2 and their children, and Person 3 and their children.

· The company shares were distributed 50% to Person 1, 25% to Person 2, and 25% to Person 3.

Person 1 died a number of years ago. They left a will which bequest the company shares to Person 2 and Person 3 in equal shares as tenants in common.

Person 2 died later. They had left a will and these details were supplied.

Relevant legislative provisions

Income Tax Assessment Act 1936 former section 160ZZRR(1)

Income Tax Assessment Act 1936 former section 160ZZS

Income Tax Assessment Act 1936 former subsection 160ZZS(1)

Income Tax Assessment Act 1997 Subdivision 149-B

Income Tax Assessment Act 1997 subsection 149-15(1)

Income Tax Assessment Act 1997 subsection 149-15(3)

Income Tax Assessment Act 1997 section 149-30

Income Tax Assessment Act 1997 subsection 149-30(1)

Income Tax Assessment Act 1997 subsection 149-30(3)

Income Tax Assessment Act 1997 subsection 149-30(4)

Reasons for decision

Detailed reasoning

In certain circumstances where the beneficial interests in a privately held company change, subsection 149-30(1) of the ITAA 1997 (and similarly former subsection 160ZZS(1) of the ITAA 1936) will cause any of the company's assets acquired prior to 20 September 1985 to lose their pre-CGT status.

The shares in the company have been divided into two classes, being either A Class or B Class. A Class shares entitle the shareholder to receive dividends and a return of paid-up capital, however the shareholder cannot participate in receiving any of the surplus on a winding up of the company. B Class shares entitle the shareholder to receive dividends and a return of paid-up capital as well as being entitled to participate in receiving the surplus on a winding up of the company. Since a specific date there have been A Class shares on issue and B Class shares on issue.

Immediately prior to 20 September 1985 the shareholdings in the company were:

A Class a specific number held by Deceased estate 1 with Person 1 as life tenant and Person 2 and Person 3 as remaindermen.

B Class a specific number held by Person 1

a specific number held by X Trust.

Since this time there have been three main changes to the beneficial interests in the company.

First change - vesting of X Trust

The holdings of the B Class shares changed due to the vesting of X Trust. As a result of the vesting the holders of B Class shares were:

Person 1 a specific number

Person 2 a specific number

Person 3 a specific number

A Class shares were unaffected by the vesting of X Trust.

As this change occurred after 19 September 1985 it is necessary to consider whether the changes in the shareholdings change the majority underlying interests (MUI) in the assets of the Company for the purposes of subsection 160ZZS(1) of the ITAA 1936. This provision states:

160ZZS(1)  [Deemed acquisition after 19 September 1985]

For the purposes of the application of this Part in relation to a taxpayer, an asset acquired by the taxpayer on or before 19 September 1985 shall be deemed to have been acquired by the taxpayer after that date unless the Commissioner is satisfied, or considers it reasonable to assume, that, at all times after that date when the asset was held by the taxpayer, majority underlying interests in the asset were held by natural persons who, immediately before 20 September 1985, held majority underlying interests in the asset.

It is necessary to examine the MUI in the assets of the Company and see whether natural persons who held the MUI in the assets of the company prior to 20 September 1985 still held the MUI in the assets of the company after the change of shareholdings arising from the vesting of the trust. If it can be concluded that the MUI is still held by the same natural persons at this point, the assets of the company that were acquired prior to 20 September 1985 will not be deemed to have been acquired after this date.

The term 'majority underlying interests' is defined in subsection 160ZZRR(1) of the ITAA 1936 as being:

majority underlying interests , in relation to an asset, means more than one-half of:

(a) the beneficial interests that natural persons hold (whether directly or indirectly) in the asset; and

(b) the beneficial interests that natural persons hold (whether directly or indirectly) in any income that may be derived from the asset.

The test has two elements that must be satisfied. The first is that beneficial interests must be held by natural persons whether directly or indirectly in the asset and the second is that beneficial interests must be held by natural persons whether directly or indirectly in any income that may be derived from the asset. The interests must add up to being more than one half of the beneficial interests.

Applying these tests to the shares in the company finds that both A Class and B Class shares entitle the holder to receive dividends. Therefore paragraph (b) of the definition would be satisfied.

As far as satisfying the test for a beneficial interest in the assets of the company is concerned there is a difference in the rights attaching to the two classes of shares. The holders of B Class shares do have a right to participate in the surplus arising on a winding up of the company. However, A Class shares have a restriction in that the holders of these shares cannot participate in any surplus arising from the winding up of the company.

As to whether this restriction means that holders of A Class shares in the company do not have beneficial interests in the assets of the company for the purposes of the test above, an analogy can be found from cases involving partnerships.

In the High Court decision Livingston v Commissioner of Stamp Duties (Queensland) [1960] 107 CLR 411 Kitto J stated the following:

An analogy may be seen also in the case of a partner's interest in the partnership assets. That he has a beneficial interest, which the law will recognize and enforce, in every piece of property which belongs to the partnership is clearly established: In re Holland; Brettell v Holland; Manley v Sartori; In re Fuller's Contract; and none the less so because the nature of the interest is peculiar in that his share in the partnership, by virtue of which the interest in a given asset exists while the asset belongs to the partnership, consists not of a title to specific property but of a right to a proportion of the surplus after the realization of the assets and payment of the debts and liabilities of the partnership: In re Ritson, Ritson v Ritson; Bakewell v Deputy Federal Commissioner of Taxation; that is to say, not a "definite" share or interest in a particular asset, no "right to any part" of it, but an interest which "can be finally ascertained only when the liquidation has been completed, and … consists of his share of the surplus": Rodriguez v Speyer Brothers.

In the High Court decision in Canny Gabriel Castle Jackson Advertising Pty Ltd v. Volume Sales (Finance) Pty Ltd [1974] 131 CLR 321, McTiernan, Menzies and Mason JJ stated the following:

The nature of a partner's interest in the partnership property has often been explained. The partner's share in the partnership is not a title to specific property but a right to his proportion of the surplus after the realization of assets and the payment of debts and liabilities. However, it has always been accepted that a partner has an interest in every asset of the partnership and this interest has been universally described as a "beneficial interest", notwithstanding its peculiar character. The assets of a partnership, individually and collectively, are described as partnership property (Partnership Act, 1892, as amended (N.S.W.), s. 20). This description acknowledges that they belong to the partnership, that is, to the members of the partnership.  

From these authorities it seems that if an entity does not have the right to participate in the surplus proceeds of a winding up of another entity; it could not be regarded as having a beneficial interest in the assets of that other entity. This applies to the A Class shareholders of the company, and implies that they do not have a 'beneficial interest' in the assets of the company, including the pre-CGT assets. Only the interests of B Class shareholders, X Trust and Person 1, are beneficial interests which meet both paragraphs (a) and (b) of the definition of MUI and are relevant to the application of subsection 160ZZS(1) of the ITAA 1936.

IT 2340 discusses discretionary trusts in relation to the continuity of MUI and when it would be reasonable to conclude there is no change in MUI. As a result of the vesting, Person 1, Person 2 and Person 3 held each of the shares previously owned by X trust. It is noted that these individuals were beneficiaries of X trust who had received distributions from that trust and in whose favour the trust had been administered throughout its duration.

For the purposes of section 160ZZS of the ITAA 1936, per IT 2340 paragraphs 5 to 7, it is reasonable to conclude that under these circumstances the MUI in the assets of the company did not change as a result of the vesting of X trust.

Second change - death of Person 1

The next change affecting shareholdings was the death of Person 1. Person 1's B Class shares passed to Person 2 and Person 3 with the remaining single share being held jointly by Person 2 and Person 3. The result was that Person 2 and Person 3 now held B Class shares each and also a half-interest in a single B Class share.

The applicable law also changed since the previous change in shareholdings. At this time, Division 149 of the ITAA 1997 contained the relevant provisions to see if MUI in assets of the Company still continued. Subsection 149-30(1) of the ITAA 1997 as it applied for the relevant year stated:

The asset stops being a pre-CGT asset at the earliest time when majority underlying interests in the asset were not had by ultimate owners who had majority underlying interests in the asset immediately before 20 September 1985. Also Part 3-1 and this Part (except this Division) apply to the asset as if the entity had acquired it at that earliest time.

The expression 'majority underlying interests' carries over the definition from the ITAA 1936 and means more than 50% of the beneficial interests that ultimate owners have whether directly or indirectly in the asset and any ordinary income that may be derived from the asset (subsection 149-15(1) of the ITAA 1997). An ultimate owner includes an individual (subsection 149-15(3) of the ITAA 1997).

Subsection 149-30(3) and 149-30(4) of the ITAA 1997 provide that, for the purposes of Subdivision 149-B of the ITAA 1997, if an ultimate owner (new owner) has acquired an interest in an asset because it was transferred to the new owner because of the death of a person (the former owner), the new owner is treated as having held the underlying interest of the former owner over the years. Essentially the new owners stand in the shoes of the former owners.

In the present case Person 2 and Person 3 had their own holdings of B Class shares in the company as well as those they inherited from Person 1. As such, the MUI were not disturbed by this change.

Third change - death of Person 2

The beneficiaries of their estate for shares in the company are:

· Person 4

· Person 5 and their children

· Person 6 and their children

· Person 7

Person 2 provided in their will, the company shares held by Person 2 are to pass to people who have not previously held shares in the company. Nevertheless, by the operation of subsection 149-30(3) and 149-30(4) of the ITAA 1997, the new owners are taken to hold the same underlying interests in the company assets as were held by the former owners. Subsection 149-30(1) of the ITAA 1997 is not applicable at this time.

In conclusion, the changes in the underlying interest as detailed in the facts have not resulted in the application of subsection 160ZZS(1) of the ITAA 1936 or subsection 149-30(1) of the ITAA 1997. Therefore, the assets acquired by the company prior to 20 September 1985, are not deemed to have been acquired by the company after that date, and retain their pre-CGT status up to and immediately after a specific date.

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