Edited version of private ruling

Authorisation Number: 1011724776404

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Ruling

Subject: Maximum net asset value test

Question

Will an amount paid for the issued capital of the company in excess of the valuations received form part of the market value for the purposes of determining the net value of capital gains tax (CGT) assets under section 152-20 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer: Yes.

This ruling applies for the following period:

Year ended 30 June 2008

The scheme commences on:

1 July 2007

Relevant facts and circumstances

You held directly and indirectly (through entities connected with you) part of the issued capital of a company.

All of the issued capital of the company was subsequently acquired by another entity.

The other entity was anxious to enter the business. This was not known by the wider market and was only known by people employed by the purchasing entity.

You commissioned several separate independent valuers who had no relationship with the company and/or its directors or shareholders. The valuers advised that the value of the business and therefore the company was substantially less than the sale price immediately prior to the sale.

You have forwarded copies of the valuations with your application.

The business was sold by private sale.

The purchasing entity approached the company to purchase the business. The initial offer was not calculated based on earnings or any other ascertainable formulae.

The offer was subject to due diligence. The due diligence was not to determine profits or earnings but to ascertain the true nature of assets and contracts of the company.

Another entity expressed an interest in reviewing the business but required the company to take the business off the market for a period of time. Upon becoming aware of this approach, the purchasing entity immediately offered a further amount.

The directors of the company determined the initial sale price based on an amount that was required to extinguish all debt, cover the value of plant and equipment and provide sufficient funds so the individuals would not need to work again. The price the directors were willing to accept was based on their personal requirements and did not reflect business valuation methodology.

Little meaningful discussion took place in relation to the purchase price.

The purchasing entity indicated that they intended to carry on the business. They further intended to replicate the business model in strategic locations world wide as well as acquire businesses in related fields to avoid takeover. Immediately after the purchase, you were retained by the purchasing entity and you were required to replicate the business overseas.

There were two further expressions of interest, however neither entity made an offer to purchase.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 152-15

Income Tax Assessment Act 1997 Section 152-20

Does Part IVA apply to this ruling?

Part IVA of the Income Tax Assessment Act 1936 (ITAA 1936) is a general anti-avoidance rule that can apply in certain circumstances if you or another taxpayer obtains a tax benefit in connection with an arrangement and it can be concluded that the arrangement, or any part of it, was entered into or carried out by any person for the dominant purpose of enabling a tax benefit to be obtained. If Part IVA applies the tax benefit can be cancelled, for example, by disallowing a deduction that was otherwise allowable.

We have not fully considered the application of Part IVA of the ITAA 1936 to the arrangement you asked us to rule on, or to an associated or wider arrangement of which that arrangement is part.

If you want us to rule on whether Part IVA of the ITAA 1936 applies we will first need to obtain and consider all the facts about the arrangement which are relevant to determining whether Part IVA may apply.

For more information on Part IVA, go to our website www.ato.gov.au and enter 'part iva general' in the search box on the top right of the page, then select: Part IVA: the general anti-avoidance rule for income tax.

Reasons for decision

The maximum net asset value test in section 152-15 of the ITAA 1997 requires that the total net value of CGT assets owned by you, entities connected with you, and any affiliates of yours or entities connected with those affiliates did not exceed $6 million just before the CGT event that results in the capital gain for which the concessions are sought.

Section 152-20 of the ITAA 1997 provides the meaning of 'net value of the CGT assets'. Under subsection 152-20(1) of the ITAA 1997, the net value of the CGT assets of an entity is the amount (whether positive, negative or nil) by which the sum of the market values of those assets exceeds the sum of the liabilities of the entity that are related to the assets and certain provisions made by the entity.

In your case, the issued capital of the company was acquired by an arm's length purchaser. You have argued that the purchaser for their own reasons was prepared to pay an amount far in excess of what the true market value was. You have provided several valuations each showing a substantially lower market value for the business being carried on by the company.

Market value

In Brisbane Water County Council v. Commr of SD (NSW) 80 ATC 4051, Waddell J indicated that the market value is the best price which may reasonably be obtained for the property if it was sold in the general market. He went further to say that the value of an item of property is its value in the general market with three qualifications, namely:

1. If there is no general market, as in the case of shares in a private company, such a market is to be assumed

2. All possible purchasers are to be taken into account, even a purchaser prepared for his own reasons to pay a fancy price

3. The value to be ascertained is the value to the seller.

Further, market value of an asset should be assessed with regard to the highest and best use of the asset as recognised in the market. The concept of highest and best use takes into account any potential for a use that is higher than the current one.

The current use of an asset may not reflect its optimal value. Optimal value is defined by the International Valuations Standards Committee as:

the most probable use of a property which is physically possible, appropriately justified, legally permissible, financially feasible, and which results in the highest value of the property being valued.

It is sometimes argued that an asset has special value to a particular buyer. Usually this is not relevant in deriving a market value. Where there is clear evidence that the special value is known or available to a wider market, this would be reflected in an objective valuation of the asset. If a special value is known and available to one potential buyer and not known or available to the wider market, it will not be reflected in market value.

Applying the above guidelines to your circumstances

You state that the purchaser in your case has applied a special value to the issued capital and business of the company. This special value would also be known to any wider market, and would therefore be reflected in an objective valuation of the business. The company business did not have any special attribute known only to the purchaser. All of the qualities and attributes of the business which were known by purchasing entity would have been known to the wider market at the time, and there was no unique special value that was attributable only to this entity.

Therefore, the market value of the business or the issued capital of the company is considered to be its ultimate selling price. The realised price was arrived at by the market determining the highest and best use of that asset. Whilst other potential buyers might have been prepared to pay significantly less than the ultimate selling price, their potential use of the business might not have been considered the highest and best use, which would accordingly be reflected in the amount that they would be prepared to pay to acquire the business.

An amount paid for the issued capital of the company in excess of the valuations will therefore form part of the market value for the purposes of determining the net value of CGT assets under section 152-20 of the ITAA 1997.

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