Edited version of private ruling

Authorisation Number: 1011718920658

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Ruling

Subject: Capital gains tax - general value shifting

Issue 1

Question 1

Does section 725-50 of the Income Tax Assessment Act 1997 (ITAA 1997) apply in respect of the Share Reorganisation so as to trigger section 104-250 of the ITAA 1997 (CGT event K8) and the requirement of cost base and reduced cost base for the purposes of Subdivision 725-D of the ITAA 1997?

Answer

No.

Issue 2

Question 1

On the basis that section 727-100 of the ITAA 1997 applies in respect of the Share Reorganisation, is it correct that the consequences in Subdivision 727-G of the ITAA 1997 in respect of the Share Reorganisation are:

· The reduction of a (future) realised loss that would, apart from Division 727, be realised for income tax purposes in respect of an affected interest in a losing entity; and

· That the indirect value shift rules do not adjust the cost, cost base or reduced cost base of the relevant equity or loan interest?

Answer

Yes.

Issue 3

Question 1

Will the Share Reorganisation give rise to a taxable capital gain under Section 104-155 of the ITAA 1997 (CGT event H2)?

Answer

No.

Issue 4

Question 1

Does Part IVA apply in respect of the Share Reorganisation?

Answer

No.

This ruling applies for the following periods:

1 April 2010 to 31 March 2011, and

1 April 2011 to 31 March 2012

The scheme commences on:

1 April 2010

Relevant facts

"A" is a company. It and its subsidiaries are in business.

"A" is a tax resident of an overseas country whose shares are listed on an overseas Stock Exchange.

There is one class of shares on issue in "A", called 'Common shares'. Since incorporation, "A" has never paid a dividend.

Prior to a specific date, a substantial percentage of the public investment in "A" was held through investments in company "B". "B" is a company who directly, or indirectly through its subsidiaries owns common shares in "A".

One of the subsidiaries "C" is a resident company for Australian tax purposes.

On a specific date "A" acquired all of the shares in "B" as part of a reverse takeover, with the effect that "B" and its subsidiaries (collectively referred to as the Group) became wholly owned subsidiaries of "A". The Group's shares in "A" are referred to in this application as 'the Circular shareholdings'. The Circular shareholdings remain on foot and continue to be held by "B" and its subsidiaries. Most of the remaining shares in "A" are widely held.

Recently, an announcement was made that corporation "E" and "A" had entered into an Arrangement Agreement for "E" to acquire all of the outstanding Common shares in "A" held by the Public for a specific price per share in cash or a specific percentage of an "E" share, or for a combination thereof.

The implementation of the agreement will be subject to shareholder approvals being obtained.

It is understood for tax purposes that more than 50% of the fair market value of the Common shares is derived directly or indirectly from the assets situated in the overseas country.

Neither "A", nor any of its wholly owned subsidiaries own any real property situated in Australia.

In summary, the steps in the "A" acquisition (including the Share Reorganisation, if it proceeds) are as follows:

Step 1:

"A" will amend its articles of incorporation to create a special class of shares.

Step 2:

Each outstanding Common share of "A" other than shares held by any Affiliate of "A" (i.e. the Circular shareholdings) shall be exchanged for one special class of share.

Step 3:

The "A" Common shares that were exchanged for the special class of shares shall be cancelled and the appropriate entry shall be made in "A"'s share register.

Step 4:

The special class of shares other than shares held by "E" or any Affiliate thereof shall be transferred to "E" in exchange for a cash payment equal to a specific price per share or a specific percentage of an "E" share.

Relevant legislative provisions

Income Tax Assessment Act 1936 Section 177D

Income Tax Assessment Act 1997 Subsection 103-10(1)

Income Tax Assessment Act 1997 Section 104-155

Income Tax Assessment Act 1997 Subsection 104-155(1)

Income Tax Assessment Act 1997 Subsection 104-155(3)

Income Tax Assessment Act 1997 Section 104-250

Income Tax Assessment Act 1997 Subsection 116-20(2)

Income Tax Assessment Act 1997 Section 725-50

Income Tax Assessment Act 1997 Section 725-55

Income Tax Assessment Act 1997 Section 725-90

Income Tax Assessment Act 1997 Section 725-145

Income Tax Assessment Act 1997 Section 725-150

Income Tax Assessment Act 1997 Section 727-100

Income Tax Assessment Act 1997 Subsection 727-150(3)

Income Tax Assessment Act 1997 Section 727-355

Income Tax Assessment Act 1997 Subsection 727-355(1)

Income Tax Assessment Act 1997 Subsection 727-355(2)

Income Tax Assessment Act 1997 Subsection 727-355(3)

Income Tax Assessment Act 1997 Section 727-460

Income Tax Assessment Act 1997 Section 727-465

Income Tax Assessment Act 1997 Subsection 727-520(3)

Income Tax Assessment Act 1997 Section 727-615, and

Income Tax Assessment Act 1997 Subdivision 768-G

Issue 1 Question 1

Detailed reasoning

The conditions that must be satisfied before there are consequences for the rulee "C" under the direct value shifting rules are set out in section 725-50 of the ITAA 1997. There must be:

· a direct value shift (hereafter DVS), as defined in section 725-145 of the ITAA 1997;

· the target entity "A" is a company at some time during the scheme period;

· the controlling entity test in section 725-55 of the ITAA 1997 is satisfied - another entity 'controls for value shifting purposes the target entity at some time during the scheme period;

· "C" is an affected owner of an up interest, or a down interest, or both;

· There will not be a reversal in the manner described in section 725-90 of the ITAA 1997.

Relevant to the facts of this arrangement are whether there is a direct value shift under the Share Reorganisation arrangement, and whether the controlling entity test is satisfied.

There is a direct value shift under a scheme involving equity or loan interests in an entity where there is:

· A decrease in the market value of one or more equity or loan interests in that entity that is reasonably attributable to a thing or things done under the scheme: section 725-145 of the ITAA 1997; and either

· Other equity or loan interests in the entity must either:

· increase in the market value; or

· be issued at a discount to market value (as defined in section 725-150 of the ITAA 1997)

[The increase in market value or issue at a discount must be reasonably attributable to the same thing or things that caused the decrease to happen].

The share re-organisation arrangement is a scheme involving equity and loan interests. The proposed exchange of the public shareholder's Common shares for the special class of shares causes a reduction in the market value of the cross held (Circular) shares held by "C" and the other members of the Group in "A".

The question is whether there is an increase in the market value, or issue at a discount, of any equity or loan interest in "A" that can reasonably be attributed to the thing or things under the scheme which caused the decrease in the market value of the Common held shares.

The facts of the arrangement, include, as relevant, a description of the legal and practical implications of the holding of "A"'s Common shares held by its subsidiaries, and the terms of "E"'s offer, under which the amount of consideration payable to public shareholders will be the same whether or not the share re-organisation has been implemented. Also included is historical share price information from the relevant Stock Exchange at the times before and after the proposed Share Reorganisation was announced. There is no evident impact on the market value of the public shareholder's shares as a result of the announced share re-organisation. The facts of the arrangement also show that mechanism by which the public shareholders become the owners of special class of shares is an exchange of their Common shares, which will be cancelled by "A" following the implementation of the arrangement.

These facts, taken together, support the conclusion that the Share Reorganisation arrangement will not result in an increase in the market value, or issue at a discount, of shares in "A" such as would satisfy the definition of a direct value shift in section 725-145 of the ITAA 1997.

The controlling entity test in section 725-55 of the ITAA 1997 will be satisfied where an entity 'controls for value shifting purposes' the target entity at some time during the 'scheme period'.

'Scheme period' is not defined separately in the Act, and the phrase takes it's ordinary - read in the context of the provisions where it appears (including the definition of direct value shift in section 725-145 of the ITAA 1997). Based on the facts of the arrangement, for any direct value shift that could happen under the share re-organisation the relevant scheme period would end before a time when "E" would be entitled to be registered as the holder of the public shareholders' "A" shares.

An entity controls a company for value shifting purposes in one of the ways described in section 727-355 of the ITAA 1997. There is a 50% stake test and a 40% stake test (which are based on the aggregate voting, dividend and capital rights held by shareholders). There is also an 'actual control test', which is satisfied where 'an entity, alone or with its associates, in fact controls another entity: subsections 727-355(1), (2) and (3) of the ITAA 1997.

Based on the information that has been provided about the shareholdings in "A" there is no entity that controls "A" for value shifting purposes during the scheme period under the 50% stake test or 40% stake test.

For the actual control test, the explanatory memorandum to the Bill that introduced the General Value Shifting Regime explains that the control tests share characteristics drawn from tests in other areas of the law, such as the CFC rules. Control takes its ordinary meaning, and the explanatory memorandum gives as an example of actual control an entity owning a 30% interest in a company whose board of directors is accustomed to acting upon that entity's instructions: paragraphs 11.90 and 11.96 of the explanatory memorandum to New Business Tax System (Consolidation, value Shifting, Demergers and Other Measures) Bill 2002.

Under the terms of the Arrangement Agreement entered into by "A" and "E" on the specific date, "A" covenants and agrees that it will not during the period of the takeover bid made by "E" undertake certain activities in the conduct of its business, or deal with its shareholdings, without the prior written consent of "E": refer Article 5 of covenant. On the facts of this arrangement, those restrictions on the conduct business do not cause "E" to in fact control "A" in the manner described in subsection 727-355(3) of the ITAA 1997.

Issue 2 Question 1

Detailed reasoning

There is an indirect value shift where there is an unequal exchange of economic benefits between two entities: subsection 727-150(3) of the ITAA 1997. For there to be consequences for an indirect value shift the entity that provides the greater benefits (called the losing entity) must be a company or trust, and there are further threshold conditions in section 727-100 of the ITAA 1997 (about control, and non-arm's length dealing) that must be satisfied.

Where those conditions are satisfied, adjustments for the 'affected interests' in the losing entity and gaining entity may be required. These 'affected interests' can include shares held directly or indirectly in one of those entities: sections 727-460 and 727-465 and subsection 727-520(3) of the ITAA 1997. Taxpayers can elect to work out their IVS adjustments under the adjustable value method (Subdivision 727-H of the ITAA 1997) or the realisation time method (Subdivision 727-G of the ITAA 1997): section 727-550 of the ITAA 1997.

On the premise that the Share Reorganisation arrangement gives rise to an indirect value shift for which the threshold conditions are satisfied, the common shares held by "C" in "A" would be, relevantly, affected interests in a losing entity.

If the realisation time method of adjustment is chosen for the indirect value shift, the consequences for the common shares held by "C" in "A" would be limited to those listed in section 727-615 of the ITAA 1997:

'… a loss that would, apart from this Division, be ^*realised for income tax purposes by the event is reduced by an amount that is reasonable having regard to …. a reasonable estimate of the amount (if any) by which the ^*indirect value shift has reduced the interest's *market value'.

There are no other consequences under the realisation time method of adjustment for an affected interest in the losing entity.

Issue 3 Question 1

Detailed reasoning

CGT event H2 in section 104-155 of the ITAA 1997 happens when an act, transaction or event occurs in relation to a CGT asset owned by the taxpayer, and the act, transaction or event does not result in an adjustment being made to the asset's cost base or reduced cost base: subsection 104-155(1) of the ITAA 1997. There are exceptions to the event listed in subsection 104-155(5) of the ITAA 1997.

Where the event happens, and no exception applies, a taxable capital gain will arise under CGT event H2 where the capital proceeds for the event are more than the incidental costs incurred. Capital proceeds are, for the purposes of CGT event H2 'the money or other consideration you received, or are entitled to receive, because of the act, transaction or event": subsection 104-155(3) and table item H2 in the table in subsection 116-20(2) of the ITAA 1997. For the purposes of the capital gains tax provisions, you are taken to receive money or other consideration if it has been applied for your benefit (including by discharging all or part of a debt you owe) or as you direct: subsection 103-10(1) of the ITAA 1997.

CGT event H2 happens to "C" under the Share Reorganisation as there is an act, transaction or event in relation to their assets (the Common shares).

Included in the facts of the arrangement on which this ruling is based, under the heading 'Step Two', is a statement that 'Neither "C" nor any related party of "A" will receive any consideration associated with the issuance of the special class of shares or for their non-participation in the Public's exchange of the Common shares for the special class of shares'. The scheme documents that have been incorporated by reference in the facts of the arrangement (including file notes and the information Circular) describe the steps that will be taken to effect the Share Reorganisation and, in doing so, describe the rights and obligations of the holders of "A"'s common shares both before and after that time. Those documents also describe the manner in which common shareholders will participate in the Share Reorganisation, and the subsequent share exchange involving "E".

These documents do not show any consideration as being received by "C", or by another person at "C"'s direction, under the Share Reorganisation arrangement. Hence no taxable capital gain arises under CGT event H2.

Issue 4 Question 1

Detailed reasoning

Neither the proposed arrangement, nor any part of it, is a scheme the dominant purpose of which is to obtain a tax benefit, within the meaning of Part IVA of the Income Tax Assessment Act 1936 (ITAA 1936).

In reaching that conclusion the following considerations are relevant.

The Share Reorganisation has a legitimate commercial purpose, aside from any tax considerations. The Reorganisation is optional in the sense that it is not commercially imperative; the benefits of it to "A" group of companies are relatively modest (the more so, if, as is expressly contemplated in the arrangement, the "E" takeover succeeds). The group could tolerate the continued existence of the Circular shareholdings indefinitely, if the costs of the Reorganisation (including any tax costs) were seen to outweigh the benefits.

In summary, answering the question posed by Part IVA normally requires the identification of an 'alternative postulate'. That raises the question of by what other means the taxpayer may reasonably and realistically be expected to achieve the same, or substantially the same, commercial objectives. One then asks whether that alternative means would have put the taxpayer in a different tax position compared with the scheme actually to be carried out, such that one of the defined kinds of 'tax benefit' is seen to arise. If there is such a tax benefit, the critical question then is whether, having regard to the factors set out in section 177D of the ITAA 1936, it would be concluded that the dominant purpose of entering into the scheme is to obtain that tax benefit.

In this case, the group might conceivably have chosen to eliminate the problem of the Circular shareholding of "C" in several alternative ways, each of which would involve a disposal or redemption of the relevant shares by one means or another. In particular, the following are possible options:

1. Before the acquisition of "A" by "E", the Circular shareholders (including "C"'s shareholding in "A") could be sold to "E";

2. After completion of the Plan of Arrangement (but without the Share Reorganisation) the Circular shareholders could sell the shares to "E" for cash or a loan note;

3. After completion of the Plan of Arrangement (but without the Share Reorganisation), "B"'s shareholding in "C" (or "A"'s shareholding in "B") is sold to "E";

4. After completion of the Plan of Arrangement within the Share Reorganisation, "C" could sell the shares to "E" (or "A" could redeem the shares).

In considering these possibilities, it is assumed purely for the sake of the argument (and contrary to the taxpayer's position), without resolving the point, that the participation exemption in Subdivision 768-G of the ITAA 1997 would not apply to any CGT event arising under one of these possibilities owing to the effect of a specific section of an overseas Act. As will be seen, this adverse assumption does not affect the ultimate conclusion on Part IVA.

Possibility 1 may be rejected as unlikely as it would require "E" to raise additional funds before taking control of "A". This would make it more difficult for it to achieve that objective, which is far more important than eliminating the Circular shareholdings. That being so, and comparing the two possibilities more generally, a consideration of the factors in section 177D of the ITAA 1936 against this alternative possibility would not support a conclusion that the actual scheme has a dominant purpose of obtaining a tax benefit.

Possibility 2, it is said, would give rise to a significant overseas tax cost (as measured against the maximum possible Australian tax cost of undertaking this Possibility, compared with the actual arrangement. Assuming this to be true, it would again be difficult, having regard to the factors in section 177D of the ITAA 1936 and comparing the features of the two possibilities more generally, to maintain that the dominant purpose of the actual arrangement was to obtain an (Australian) tax benefit. The same is true of Possibility 3, and moreover Possibility 3 would not give rise to any taxable event for "C", so there would be no tax benefit in any case.

Comparing the proposed scheme with Possibility 4 does not give rise to the identification of any relevant tax benefit.

Therefore Part IVA does not apply to this arrangement.

We emphasise that any Part IVA analysis is always heavily dependent on the particular facts and circumstances of the arrangement in question. Accordingly, the above analysis applies only if all of the facts asserted in the application are true, and there are no other material facts that have not been disclosed.

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