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Ruling

Subject: Capital gains tax - pre CGT status of shares in a co-operative association

Question 1

Is the 'new' share in the Co-operative (the Co-op), where that new share was allotted in replacement of your 'old' share, a pre-CGT asset for the purposes of Part IIIA of the Income Tax Assessment Act 1936 (ITAA 1936)?

Answer

No.

Question 2

Are the 'additional' shares in the Co-op 'bonus shares' for the purposes of Division 8 of Part IIIA of the ITAA 1936?

Answer

Yes.

Question 3

Are the additional shares in the Co-op pre-CGT assets for the purposes of Part IIIA of the ITAA 1936?

Answer

No.

This ruling applies for the following period:

Year ended 30 June 1986.

The scheme commenced:

1 July 1985.

Relevant facts and circumstances

You held a share (your 'old' share) in the Co-op, which you acquired at a time before 20 September 1985.

You continued to hold that old share from that time until the board of directors allotted you a 'new' share in lieu of your old share in the Co-op at a time after 19 September 1985.

In addition to the allotment of the new share, the board of directors also offered you 'additional' shares. You accepted that offer and were issued or allotted those additional shares at a time after 19 September 1985.

You need to determine the acquisition time of those shares for the purposes of working out your capital gain when CGT event A1 happens in a later income year.

Relevant legislative provisions

Income Tax Assessment Act 1936 Part IIIA

Income Tax Assessment Act 1936 Division 8

Income Tax Assessment Act 1936 Section 6

Income Tax Assessment Act 1936 Section 6BA

Income Tax Assessment Act 1936 Division 17

Income Tax Assessment Act 1936 Section 160A

Income Tax Assessment Act 1936 Section 160M

Income Tax Assessment Act 1936 Subsection 160M(1)

Income Tax Assessment Act 1936 Subsection 160M(3)

Income Tax Assessment Act 1936 Paragraph 160M(3)(c)

Income Tax Assessment Act 1936 Subsection 160M(5)

Income Tax Assessment Act 1936 Section 160U

Income Tax Assessment Act 1936 Subsection 160U(3)

Income Tax Assessment Act 1936 Section 160ZD

Income Tax Assessment Act 1936 Paragraph 160ZD(1)(b)

Income Tax Assessment Act 1936 Section 160ZYF

Income Tax Assessment Act 1936 Section 160ZZP

Income Tax Assessment Act 1936 Subsection 160ZZP(1)

Income Tax Assessment Act 1936 Paragraph 160ZZP(1)(f)

Income Tax Assessment Act 1936 Section 160ZZPH

Income Tax Assessment Act 1997 Part 3-1

Income Tax Assessment Act 1997 Part 3-3

Income Tax Assessment Act 1997 Division 104

Income Tax Assessment Act 1997 Section 108-5

Income Tax Assessment Act 1997 Division 130

Income Tax Assessment Act 1997 Subdivision 130-A

Income Tax Assessment Act 1997 Subdivision 124-E

Income Tax Assessment Act 1997 Subsection 995-1(1).

Reasons for decision

These reasons for decision accompany the Notice of private ruling.

While these reasons are not part of the private ruling, we provide them to help you to understand how we reached our decision.

Note:

For the purposes of this document, provisions of the Income Tax Assessment Act 1936 (ITAA 1936) are discussed relevant to how they applied at the time of the events set out in the facts of the scheme.

Within this document, certain provisions of the ITAA 1936 are referenced to their corresponding equivalent within the Income Tax Assessment Act 1997 (ITAA 1997), which would currently apply to those same circumstances as set out in the facts of the scheme.

Definitions

For the purposes of this document, the following terms are used within this document and have only the following defined meaning:

· old share - is the share in the Co-op that you held before 20 September 1985 and in respect of which you were allotted a 'new' share in lieu of that share, as resolved by the Directors in the meeting of the Board of Directors.

· new share - is the share that you were allotted in lieu of your 'old' share, as resolved by the Directors in the meeting of the Board of Directors.

· additional shares - are the shares that you were issued as resolved by the Directors to offer members in the meeting of the Board of Directors and subsequent to your acceptance of that offer in accordance with the letter of offer issued to you by the Board of Directors. Any shares issued subsequent to that offer are excluded from this definition.

Detailed reasoning

General discussion of the law

Capital Gains Tax

Generally a capital gain or capital loss is made where a Capital Gains Tax (CGT) event has occurred in respect of a CGT asset.

Section 104-10 of the ITAA 1997 provides that CGT event A1 happens if you dispose of a CGT asset.

However, where you make a capital gain as a result of CGT event A1, paragraph 104-10(5)(a) of the ITAA 1997 provides that a capital gain is disregarded if you acquired the asset before
20 September 1985. CGT assets acquired before 20 September 1985 are referred to as 'pre-CGT' assets.

Further, where you can satisfy certain criteria, even though you may not have physically acquired that particular CGT asset before 20 September 1985, you may still be able to treat that asset as having been acquired before 20 September 1985. The provisions that enable this treatment are referred to as rollover relief provisions.

For the income year beginning 1 July 1985, the CGT provisions were set out within Part IIIA of the ITAA 1936. Those provisions have now been re-written into Part 3-1 and Part 3-3 of the ITAA 1997.

CGT asset

For the purposes of Part IIIA of the ITAA 1936, section 160A defines that, among other things, an "asset" means any form of property and includes:

(a) any of the following:

(i) an option;

(ii) a debt;

(iii) a chose in action;

(iv) any other right;

whether legal or equitable and whether or not a form of property;

(aa) goodwill or any other form of incorporeal property;

Section 160A of the ITAA 1936 has been rewritten in section 108-5 of the ITAA 1997, which for the purposes of Part 3-1 of the ITAA 1997, among other things provides that a 'CGT asset' includes:

(a) any kind of property; or

(b) a legal or equitable right that is not property…

Note 1:

Examples of CGT assets are:

· land and buildings;

· shares in a company and units in a unit trust;

· options;

· debts owed to you;

· a right to enforce a contractual obligation;

· foreign currency.

Note 2:

An asset is not a CGT asset if the asset was last acquired before 26 June 1992 and was not an asset for the purposes of former Part IIIA of the Income Tax Assessment Act 1936: see section 108-5 of the Income Tax (Transitional Provisions) Act 1997.

Section 6 of the ITAA 1936 defines that a 'company includes all bodies or associations corporate or unincorporate, but does not include partnerships or non-entity joint ventures'.

What constitutes a share

In relation to incorporated entities, a 'share' is considered to be a piece of intangible personal property belonging to a shareholder, in particular, intangible property known as a 'chose in action'. A share can be dealt with by a shareholder in much the same way as any other property, in that it can be sold, mortgaged, or devised by will. The Macquarie Dictionary defines that a 'chose in action' is a legal term meaning:

1. an intangible form of property as debts, shares, intellectual property, contractual rights, etc., recoverable by an action.

2. a right which can be protected only by legal action.

Subsection 995-1(1) of the ITAA 1997 defines the term 'share' and includes that a share 'in a company means a share in the capital of the company, and includes stock'. Typically shares are issued by an entity for the purpose of raising capital (equity) instead of obtaining debt financing to fund its operations. The Macquarie Dictionary defines that a 'share' is:

1. the portion or part allotted or belonging to, or contributed or owed by, an individual or group.

2. one of the equal fractional parts into which the capital stock of a limited company is divided.

Further, section 761 of the Corporations Law defines, 'shares, in relation to a body corporate, includes units in shares in the body'.

Class Ruling CR 2005/68 (now withdrawn) explains the Commissioner's view of what defines the term 'share' at paragraphs 86-88. CR 2005/68 proposes that the term share is defined in the Australian Oxford dictionary as 'any of the equal parts into which a company's capital is divided entitling its owner to a proportion of the profits'. Further, the judicial statement of the nature of a share can be found in the description of Farwell J in Borland's Trustee v. Steel Bros & Another [1901] 1 Ch 279 at 288 where he said:

A share is the interest of a shareholder in the company measured by a sum of money, for the purpose of liability in the first place, and of interest in the second, but also consisting of a series of mutual covenants entered into by all of the shareholders inter se in accordance with the Companies Act. The contract contained in the articles of association is one of the original incidents of the share. A share is not a sum of money ....but is an interest measured by a sum of money and made up of the various rights contained in the contract including the right to a sum of money of a more or less amount.

In addition, this concept of the nature of a share has not been altered by the abolition of par value in the Company Law Review amendments in 1998. In support of this, CR 2005/68 makes reference to Ford, HA, 2003, Ford's Principles of Corporations Law, 11th ed, Butterworths, Sydney, where paragraph 17.200 states:

Since the abolition of par value by amendments to the Corporations Law in 1998, a share in the company with only one class of shares is a unit or interest in the company's share capital after all prior claims on the company have been met. There will be no need to relate ordinary shareholders' rights to anything more than a number of shares. It is not enough for a company to say simply that a member is entitled of a certain fraction of the company's total share capital. The member's interest must be expressed in shares in the share capital. Even a sole shareholder must have been issued with a single share or a number of shares.

Subsection 995-1(1) of the ITAA 1997 defines that membership interests in a company or trust form a 'class' if the interests have the same, or substantially the same, rights.

Acquisition and disposal of a CGT asset

Section 160M of the ITAA 1936 dealt with what constitutes a disposal. Subsection 160M(1) of the ITAA 1936 set out that for a change in ownership:

Subject to this Part, where a change has occurred in the ownership of an asset, the change shall be deemed, for the purposes of this Part, to have effected a disposal of the asset by the person who owned it immediately before the change and an acquisition of the asset by the person who owned it immediately after the change.

Further, subsection 160M(3) of the ITAA 1936 sets out circumstances that cause a change of ownership and provides:

[Declaration of trust, choses in action, etc]

Without limiting the generality of subsection (2), a change shall be taken to have occurred in the ownership of an asset by:

(b) in the case of an asset being a debt, a chose in action or any other right, or an interest or right in or over property - the cancellation, release, discharge, satisfaction, surrender, forfeiture, expiry or abandonment, at law or in equity, of the asset;

(c) in the case of an asset being a share in or debenture of a company - the redemption in whole or in part, or the cancellation, of the share or debenture; or…

In addition, subsection 160M(5) of the ITAA 1936 provided certain circumstances where, for the purposes of Part IIIA of the ITAA 1936, an acquisition is taken to have occurred. In particular, an issue or allotment of shares in a company constitutes an acquisition of the shares by the person to whom they were issued or allotted.

Section 160U of the ITAA 1936, among other things, provided that the time of disposal and acquisition includes:

…160U(3) [Acquisition or disposal under contract]

Where the asset was acquired or disposed of under a contract, the time of acquisition or disposal shall be taken to have been the time of the making of the contract.

In the case of Alan Robert Elmslie & Ors v. Commissioner of Taxation (1993) 46 FCR 576; 26 ATR 611, 93 ATC 4964 (Elmslie's case), the taxpayers argued that an arrangement that contemplated the issue of shares, which was made prior to 20 September 1985, represented the acquisition time.

In Elmslie's case it was found that as the arrangement relied upon certain conditions being met, therefore within the meaning of subsection 160U(3), that arrangement was not the means by which the shares were ultimately acquired. Instead, as the conditions were precedent to the formation of the contract, it was held that the allotment of those shares determined the time of acquisition. In Elmslie's case the allotment occurred by the resolution of directors within a meeting of directors on
7 November 1985.

In addition, Taxation Determination TD 2002/4 discusses the Commissioner's view in relation to the cost base of a share in a company that you acquire in exchange for a share in another company. While TD 2002/4 does not directly reflect the circumstances of this case, the Commissioner does discuss that if you acquire a share by issue or allotment, the time of acquisition is when you enter into the contract to acquire the share or, if you acquire it other than under a contract, when the share is issued or allotted.

Bonus shares

Subsection 6BA(1) of the ITAA 1936 sets out the taxation treatment of certain shares and applies where a shareholder holds shares in a company (the original shares) and the company issues other shares (the bonus shares) in respect of the original shares.

Subsection 6BA(3) of the ITAA 1936 deals with the apportionment of the cost of original shares and provides that:

If the bonus shares are issued for no consideration and are not a dividend or taken to be a dividend, then for the purposes of this Act, in determining:

(a) the value of such of the original shares and bonus shares as the taxpayer elects under section 70-45 of the Income Tax Assessment Act 1997 to value at cost; and

(b) where any of the original shares or any of the bonus shares are not articles of trading stock of the taxpayer:

(i) the amount or value of the consideration paid in respect of the acquisition of any of those shares for the purposes of Part 3-1 or 3-3 of the Income Tax Assessment Act 1997; or

(ii) the amount of any profit or loss arising on the sale or disposal of any of those shares;

any amounts paid or payable by the taxpayer in respect of the original shares (whether on purchase of the shares, on application for or allotment of the shares, to meet calls or otherwise) shall be deemed to have been paid or to be payable by the taxpayer in respect of the original shares and the bonus shares in such proportions as the Commissioner considers appropriate in the circumstances.

Division 8 of Part IIIA of the ITAA 1936 dealt with bonus shares, including what constitutes a bonus share and the relevant acquisition time of those shares, which has since been re-written in Subdivision 130-A of the ITAA 1997. Section 160ZYF of the ITAA 1936 provided that a bonus share arises:

Where-

(a) a person (in this Division referred to as the "shareholder") holds shares in a company (in this Division referred to as the "original shares");

(b) the company issues other shares (in this Division referred to as the "bonus shares") to the shareholder in circumstances mentioned in subsection 6BA(1); and

(c) Division 8A does not apply to the bonus shares;

The time of acquisition of a bonus share is set out under section 160ZYG of the ITAA 1936, which provides that:

The bonus shares shall be deemed, for the purposes of this Part, to have been acquired by the shareholder at the time applicable under the following paragraphs:

(a) if:

(i) the bonus shares were issued after 1 o'clock in the afternoon, by legal time in the Australian Capital Territory, on 10 December 1986;

(ii) the original shares were acquired by the shareholder before 20 September 1985; and

(iii) after the time referred to in subparagraph (i), money has been paid to the company in respect of the bonus shares, being money that the shareholder paid or was required to pay;

the time when the liability arose to pay the money that was first paid as mentioned in subparagraph (iii); or

(b) in any other case - the time when the shareholder acquired the original shares.

Class Ruling 2011/18 provides the Commissioner's view in relation to a particular bonus share plan. However CR 2011/18 explains certain aspects regarding the application of section 6BA of the ITAA 1936. In particular, the methodology prescribed by subsection 6BA(3) is that any amounts paid or payable by the shareholder in respect of the original shares (whether on purchase of the shares, on application for or allotment of the shares, to meet calls or otherwise) shall be deemed to have been paid or to be payable by the shareholder in respect of the original shares and the bonus shares in such proportions as the Commissioner considers appropriate in the circumstances.

Variation or changes to the rights attaching to shares

The Macquarie Dictionary defines that a 'right', among other things, is:

18. a just claim or title, whether legal, prescriptive, or moral.

19. that which is due to anyone by just claim: to give one his right or his rights.

20. Finance

the privilege, usually pre-emptive, which accrues to the owners of the stock of a company to subscribe for additional stock or shares at an advantageous price.

(often plural) a privilege of subscribing for a stock or bond.

Taxation Ruling TR 94/30 discusses the Commissioner's view of the Capital Gains Tax (CGT) implications of varying rights attaching to shares.

At paragraphs 32 and 33 of TR 94/30 the Commissioner explains that considering the nature of a share, it has been the prevailing view of the courts that the rights attaching to shares cannot be dealt with separately from the share itself. It is clear that these rights were not assets under the definition of 'asset' in section 160A as it existed before being amended by the Taxation Laws Amendment Act (No 4) 1992 (TLAA (No 4) 1992).

In paragraph 8 of TR 94/30 the Commissioner states that a variation in rights attaching to a share (including those variations outlined in paragraphs 3(a) to (e) of TR 94/30) does not result in a full disposal of an asset for the purposes of Part IIIA of the ITAA 1936 unless there is a cancellation or redemption of the share. In determining whether a disposal has occurred under Part IIIA of the ITAA 1936, it is not relevant to consider whether the variation is slight (such as a small change to the nominal value of shares) or more significant (such as disposing of the preference to receive dividends).

In addition, the Commissioner's view at paragraph 9 of TR 94/30 is that a variation in rights attaching to shares does not result in a part disposal of an asset under section 160R of the ITAA 1936.

At paragraph 10 of TR 94/30 the Commissioner states that, a variation in rights does not constitute a deemed disposal under subsection 160M(6) of the ITAA 1936. However, a variation in share rights for money or other consideration does give rise to a deemed disposal under subsection 160M(7) of the ITAA 1936 where the other requirements of that subsection are met. The same results arise both before and after the amendments made by the (TLAA (No 4) 1992) to those subsections.

However, at paragraph 11 of TR 94/30 the Commissioner proposes that there is clearly a disposal for the purposes of Part IIIA where shares are redeemed or cancelled because in these circumstances paragraph 160M(3)(c) of the ITAA 1936 specifically deems a change in ownership to have occurred for the purposes of subsection 160M(1) of the ITAA 1936.

Although, paragraph 12 of TR 94/30 highlights that rollover relief is available under section 160ZZP of the ITAA 1936 where there has been a disposal in terms of subsection 160M(1) of the ITAA 1936 (when read with paragraph 160M(3)(c)) of the ITAA 1936 and where certain prerequisites are satisfied).

The Commissioner further discusses in TR 94/30 that the most pertinent of those conditions under section 160ZZP of the ITAA 1936, is that the shares of a particular class must actually be redeemed or cancelled by the company, following which the company issues new shares in substitution for the original holding of shares. However, no other consideration must flow to the taxpayer as a result of the redemption or cancellation.

For the purposes of TR 94/30, the Commissioner defines the meaning of 'cancel' and includes that the cancellation of a share means that it ceases to exist and is to be distinguished from the mere cancellation of a share certificate.

Conversion of shares into larger or smaller numbers

Taxation Ruling TR 2000/10 discusses the Commissioners view that if a company converts its shares into a larger or smaller number of shares ('the converted shares') in accordance with section 254H of the Corporations Law (Corps Law) in that:

(a) the original shares are not cancelled or redeemed in terms of the Corps Law;

(b) there is no change in the total amount allocated to the share capital account of the company; and

(c) the proportion of equity owned by each shareholder in the share capital account is maintained;

In those circumstances, no CGT event happens to the shareholder's original shares for capital gains purposes. While there is a change in the form of the original shares, there is no change in their beneficial ownership. The issue of rollover relief under section 124-240 of the ITAA 1997 does not arise because no CGT event happens to the shares.

It is considered that the power to convert shares into a larger or smaller number, contained in section 254H of Corps Law, merely allows a shareholder to take one thing, a specified number of shares representing a specific fractional entitlement to the share capital of a company, and convert that thing into something else, a different number of shares. The section does not allow shareholders a greater or lesser interest in the share capital of the company. That would not be a conversion or Subdivision as each shareholder would have a greater or lesser entitlement to any distribution of profits, or to a distribution of share capital on winding up.

Rollover relief

Division 17 of Part IIIA of the ITAA 1936 set out the miscellaneous rollover relief provisions where a capital gain arises in respect of certain circumstances. In particular, section 160ZZP of the ITAA 1936, which has been re-written in Subdivision 124-E of the ITAA 1997, deals with an exchange of shares in the same company and provides that:

160ZZP(1) [Application of section]

Where:

(a) a company redeems or cancels all the shares of a particular class in the company;

(b) a taxpayer holds shares of that class in the company (in this section referred to as the "original shares");

(c) the taxpayer is a resident of Australia or the redemption or cancellation constitutes a disposal of a taxable Australian asset;

(d) the company issues to the taxpayer other shares in the company (in this section referred to as the "new shares") in substitution for the original shares;

(e) the market value of the new shares immediately after they were issued is not less than the market value of the original shares immediately before the redemption or cancellation;

(f) the taxpayer did not receive any consideration other than the new shares by reason of the redemption or cancellation;

(g) the taxpayer has, by notice in writing given to the Commissioner on or before the date of lodgment of the return of income of the taxpayer for the year of income in which the disposal took place, or within such further period as the Commissioner allows, elected that this section is to apply in respect of the redemption or cancellation;

this Part (other than this section) does not apply in respect of the redemption or cancellation and:

(h) if the original shares were acquired by the taxpayer before 20 September 1985 - the taxpayer shall be deemed to have acquired the new shares before that date; or

(j) if the original shares were acquired by the taxpayer on or after 20 September 1985, the taxpayer shall be deemed to have paid as consideration in respect of the acquisition of the new shares an amount equal to:

(i) for the purpose of ascertaining whether a capital gain accrued to the taxpayer in the event of a subsequent disposal of the new shares by the taxpayer - the amount that would have been the indexed cost base to the taxpayer of the original shares for the purposes of this Part if this Part had applied in respect of the disposal of the original shares by the taxpayer; or

(ii) for the purpose of ascertaining whether the taxpayer incurred a capital loss in the event of a subsequent disposal of the new shares by the taxpayer - the amount that would have been the reduced cost base to the taxpayer of the original shares for the purposes of this Part if this Part had applied in respect of the disposal of the original shares by the taxpayer.

Consideration in respect of a disposal is defined in section 160ZD of the ITAA 1936. In particular, under paragraph 160ZD(1)(b) of the ITAA 1936, if a taxpayer receives property as a result of a disposal, then the taxpayer is deemed to have received the market value of the property.

Application of the law

Shares in the association

The Co-op has registered as a class of association 'having a capital divided into shares and with limited liability'. Accordingly the original rules of the Co-op set out that the capital of the association is raised by the issues of shares to qualifying members.

At the time of accepting an application for membership, the board of directors may allot a share in the association to a member, which is then recorded in the share register and a share certificate is issued.

A 'share' is an intangible asset referred to as a 'chose in action', which are defined to be CGT assets under section 160 of the ITAA 1936 (as it applied at that time) and section 108-5 of the ITAA 1997.

Therefore, as contemplated under the relevant state law and under the original rules of the Co-op, each member of the Co-op held a 'share', which is a CGT asset for the purposes of Part IIIA of the ITAA 1936 and Parts 3-1 and 3-3 of the ITAA 1997.

Cancellation of your old share

Consistent with the Commissioner's view discussed in TD 2002/4 and the principles in Elmslie's case, as the new rules of the Co-op were conditional on the approval by the registrar, the time of acquisition of your new share is determined under section 160U of the ITAA 1936. In your circumstances, it is considered that you acquired the new share at the time the board allotted the new share within a meeting of the board of directors.

As your 'new' share is allotted by the board of directors, resulting in the cancellation of your 'old' share, your old share is deemed to have been disposed of under paragraph 160M(3)(c) of the ITAA 1936.

Therefore, as you acquired the new share after 19 September 1985, the 'new' share in the Co-op is not a pre-CGT asset for the purposes of Part IIIA of the ITAA 1936.

Your new and additional shares

In review of the new rules of the Co-op, it is considered that the new share and the additional shares represent an interest in the capital of the association as contemplated within the new rules of the Co-op and as contemplated under the relevant state law.

Therefore, it is considered that the new share and additional shares in the Co-op are 'shares', which are CGT assets for the purposes of Part IIIA of the ITAA 1936 and Parts 3-1 and 3-3 of the ITAA 1997.

Further, you have acquired your additional shares at a time subsequent to your acceptance of the offer by the board of directors and payment of the nominated amount of consideration such that those additional shares were issued or allotted to you.

In consideration of your circumstances, you have acquired those additional shares after
19 September 1985. Therefore those additional shares are new CGT assets and are not pre-CGT assets for the purposes of Part IIIA of the ITAA 1936 and Parts 3-1 and 3-3 of the ITAA 1997.

Bonus shares

A bonus share, as defined in the ITAA 1936, is the issue by a company of other shares in respect of the original share.

Your additional shares are new CGT assets, which those additional shares are considered to have been issued in respect of your new share in circumstances mentioned under subsection 6BA(1) of the ITAA 1936 and are therefore bonus shares under section 160ZYF of the ITAA 1936.

As the additional shares are bonus shares, they are considered to have been acquired at the time you acquired the new share, therefore are a new CGT asset for the purposes of Part IIIA of the ITAA 1936 and Parts 3-1 and 3-3 of the ITAA 1997.

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