Edited version of your private ruling

Authorisation Number: 1012370686783

Ruling

Subject: Market Valuation for CGT purposes and Classification of Individuals

Question 1

Is the proposed methodology used in the valuation of the business acceptable for the purposes of the Capital Gains Tax - Maximum net value assets test, in section 152-15 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Advice/Answers

Yes

Question 2

Is Beneficiary A considered to be 'connected with', an 'affiliate' of, or 'connected with an affiliate' of the trust with respect of section 328-125 of the ITAA 1997?

Advice/Answers

Yes

Question 3

Is Beneficiary B considered to be 'connected with', an 'affiliate' of, or 'connected with an affiliate' of the Trust with respect of section 328-125 of the ITAA 1997?

Advice/Answers

Yes

Question 4

Is Beneficiary C considered to be 'connected with', an 'affiliate' of, or 'connected with an affiliate' of the Trust with respect of section 328-125 of the ITAA 1997?

Advice/Answers

Yes

Question 5

Is Beneficiary D considered to be 'connected with', an 'affiliate' of, or 'connected with an affiliate' of the Trust with respect of section 328-125 of the ITAA 1997?

Advice/Answers

No

Question 6

Is an Unpaid Present Entitlement (UPE) a 'liability of the entity related to the assets of the Trust for the purposes of calculating the net value of the CGT assets' of the Trust under section 152-20 (1)(a) of the ITAA 1997?

Advice/Answers

No

This ruling applies for the following periods:

1 July 2012 - 30 June 2013

The scheme commences on:

1 July 2012

Relevant facts and circumstances

Company X operates as trustee for the Trust.

Company X intends to undertake a business restructure involving the sale of a business currently carried on by the Trust to a related company.

The Trust also has 100% ownership of an associated business. The associated business purchased a similar business from an unrelated party.

The Trust has provided an indicative valuation of Company X business displaying the selection and application of the proposed valuation methodology.

The result of this valuation was that the business was valued using Earnings before Interest, Tax, Depreciation, Amortisation and Extraordinary Items (EBITDAE) averaged over financial years, and then multiplied by a factor of XYZ.

The Trust has distributed cash paid on behalf of each of the individual beneficiaries of the trust which has consistently been less that the trust income distributed to those beneficiaries.

A, B, C and D are beneficiaries of the Trust.

For the years ended 30 June 2009, 2010, 2011, 2012 none of the beneficiaries received more than 40% of the total distributable amount of income or capital of the Trust.

Beneficiary A is the Appointor of the Trust.

Beneficiary D holds no formal position with either Company X or the Trust.

Beneficiary D is not a shareholder in Company X.

Beneficiary C is employed by the Trust to act as manager for Company X.

Beneficiaries B and C are directors of Company X.

Company X's constitution states that the Chairman may have a casting vote in a case of equality of votes.

Beneficiaries B and C assume the role of chairman on occasion.

Some beneficiaries have unpaid present entitlements (UPE's).

Relevant legislative provisions

Income Tax Assessment Act 1997 Subdivision 152-A

Income Tax Assessment Act 1997 Section 152-15

Income Tax Assessment Act 1997 Subsection 152-15(b)

Income Tax Assessment Act 1997 Subsection 152-20(1)

Income Tax Assessment Act 1997 Paragraph 152-15(1)(a)

Income Tax Assessment Act 1997 Paragraph 152-30(1)(a)

Income Tax Assessment Act 1997 Section 328-125

Income Tax Assessment Act 1997 Subsection 328-125(3)

Income Tax Assessment Act 1997 Subsection 328-152(4)

Income Tax Assessment Act 1997 Subsection 328-130(1)

Income Tax Assessment Act 1997 Subdivision 960-S

Income Tax Assessment Act 1997 Section 960-400

Income Tax Assessment Act 1997 Section 995-1

Butterworths Australian Legal Dictionary 1997, (Butterworths)

The Macquarie Dictionary revised 3^rd edition

Reasons for decision

Question 1

Is the proposed methodology used in the valuation of the business acceptable for the purposes of the Capital Gains Tax - Maximum net value assets test, in section 152-15 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Summary

The proposed methodology which has been provided by Company X to be used in the valuation of the business is acceptable for the purposes of the Capital Gains Tax - Maximum net value assets test, in section 152-15 of the ITAA 1997.

Detailed reasoning

A definition of market value is not provided in a general provision in the current tax law. Section 995-1 of the ITAA 1997 defines market value as having a meaning affected by Subdivision 960-S of the ITAA 1997. However, Subdivision 960-S at section 960-400 provides that the expression market value is often used in this Act with its ordinary meaning.

The High Court case Spencer v The Commonwealth of Australia (1907) 5 CLR 418 (Spencer v The Commonwealth) casts some light on the ordinary meaning of market value. In this case it was held that a valuation of land should be based on the price that a willing purchaser at the date in question would have had to pay to a vendor not unwilling, but not anxious to sell.

In looking to apply the concept of 'willing buyer and willing seller' to ascertain the market value of land, Griffith CJ commented at page 432 that:

…the test of value of land is to be determined, not by inquiring about what price a man desiring to sell could have obtained for it on a given day, i.e. whether there was, in fact, on that day a willing buyer, but by inquiring: What would a man desiring to buy the land have had to pay for it on that day to a vendor willing to sell it for a fair price but not desirous to sell?

The definition of market value in Spencer v The Commonwealth embraces the following principles:

· The purchaser is willing but not anxious to buy

· The seller is willing but not anxious to sell and

· The purchaser is assumed to be independent and dealing at arm's length with the seller.

In the context of proposed methodology used in the valuation of Company X business for the purposes of the maximum net assets test in section 152-15 of the ITAA 1997 the task of establishing the market value of an asset is approached with the typical definition in mind. That is, market value is generally taken to mean the price that would be negotiated in an open and unrestricted market between a knowledgeable, willing but not anxious buyer and a knowledgeable, willing but not anxious seller acting at arm's length.

The principles in Spencer v The Commonwealth is particularly relevant to consolidation as the consolidation legislation focuses on the head company's cost of acquiring the joining entity's assets at the joining time.

Importantly, the approaches to market valuation need to be tailored to the facts and circumstances of each case and the result of the valuation should reflect the underlying purpose of the statutory provisions.

In this case, the services of the Australian Valuation Office (AVO) were engaged in determining if the methodology used by the Trust in calculating the worth of Company X.

The AVO has provided a Report.

The AVO summary explains the reasons why the AVO considers the methodology used to value the business as generally acceptable.

In addition to the primary methodology, the AVO recommends also using a secondary valuation method as a means for cross checking.

It is accepted that the proposed methodology which has been provided by the Trust to be used in the valuation of the business is acceptable for the purposes of the Capital Gains Tax - Maximum net value assets test, in section 152-15 of the ITAA 1997.

Question 2

Is Beneficiary A considered to be 'connected with', an 'affiliate' of, or 'connected with an affiliate' of the trust with respect of section 328-125 of the ITAA 1997?

Summary

Beneficiary A is considered to be connected with the Trust in accordance with section 328-125 of the ITAA 1997.

Detailed reasoning

To qualify for the small business CGT concessions, a taxpayer must satisfy the basic conditions provided in Subdivision 152-A of the ITAA 1997. One of the basic conditions is the maximum net asset value test.

This test is detailed at section 152-15 of the ITAA 1997 where:

You satisfy the maximum net asset value test if, just before the CGT event, the sum of the following amounts does not exceed $6,000,000:

a) the net value of the CGT assets of yours;

b) the net value of the CGT assets of any entities connected with you;

c) the net value of the CGT assets of any affiliates of yours or entities connected with your affiliates (not counting any assets already counted under paragraph (b)).

The proper interpretation of the Maximum Net Assets Value Test, in the context of legislation provided in concession for small business owners, is one which requires the assets to be taken into account where they are owned by the taxpayer, entities controlled by the taxpayer (connected entities) and assets for which the taxpayer has de facto ownership (CGT affiliates). Accordingly, assets held by an agent or nominee of the taxpayer will be taken into account upon the basis they are held by a person that acts in accordance with the taxpayer's directions or wishes.

Continuing in accordance with subsection 152-15(b) of the ITAA 1997; it is indicated that any entities connected with you are included in calculating the value of assets for the purposes of the maximum net asset value test. Section 995-1 of the ITAA 1997 provides direction that the definition of 'connected with' is found at subsection 328-125 of the ITAA 1997 as follows;

…

Direct control of a discretionary trust

An entity (the first entity) controls a discretionary trust if a trustee of the trust acts, or could reasonably be expected to act, in accordance with the directions or wishes of the first entity, its affiliates, or the first entity together with its affiliates.

An entity (the first entity) controls a discretionary trust for an income year if, for any of the 4 income years before that year:

(a) the trustee of the trust paid to, or applied for the benefit of:

(i) the first entity; or

(ii) any of the first entity's affiliates; or

(iii) the first entity and any of its affiliates;

any of the income or capital of the trust; and

(b) the percentage (the control percentage) of the income or capital paid or applied is at least 40% of the total amount of income or capital paid or applied by the trustee for that year.

…

Commissioner may determine that an entity does not control another entity

…

Indirect control of an entity

…

...

In this case, we are examining if Beneficiary A is 'connected with' the Trust. Beneficiary A is the trust's Appointor. Clear direction regarding an Appointor's control is given in ATO Interpretative Decision ATO ID 2008/139 Income Tax, CGT: small business concessions- whether Appointor controls discretionary trust (ATO ID 2008/139), where it states:

If the trust deed of a discretionary trust specifies that the appointor of the trust has the power to remove a trustee and appoint a new trustee, it is considered that the trustee could reasonably be expected to act in accordance with the directions or wishes of the appointer. In this situation, the Appointor will control the Discretionary Trust under subsection 328-125(3) of the ITAA 1997.

This is also confirmed in Taxation Determination TD 2006/67 where, if an Appointor is defined in the Trust Deed to have control of removing and appointing a new trustee, they are deemed to be connected with each other for the purposes of the former paragraph 152-30(1)(a) of the ITAA 1997.

In the role of Appointor of the Trust, Beneficiary A has the authority to appoint a trustee or to dismiss the Trustee in the event of a dispute. Therefore control of the Trust by the Trustee can be taken away by the Appointor.

Therefore, for the purposes of section 328-125 of the ITAA 1997, it is considered that Beneficiary A is connected with the Trust.

Question 3

Is Beneficiary B considered to be 'connected with', an 'affiliate' of, or 'connected with an affiliate' of the trust with respect of section 328-125 of the ITAA 1997?

Summary

Beneficiary B is considered to be connected with the Trust in accordance with section 328-125 of the ITAA 1997.

Detailed reasoning

To qualify for the small business CGT concessions, a taxpayer must satisfy the basic conditions provided in Subdivision 152-A of the ITAA 1997. One of the basic conditions is the maximum net asset value test.

The Maximum Net Assets Value Test, requires the assets to be taken into account where they are owned by the taxpayer, entities controlled by the taxpayer (connected entities) and assets for which the taxpayer has de facto ownership (CGT affiliates). Accordingly, assets held by an agent or nominee of the taxpayer will be taken into account upon the basis they are held by a person that acts in accordance with the taxpayer's directions or wishes.

Subsection 152-15(b) of the ITAA 1997 indicates that any entities connected with you are included in calculating the value of assets for the purposes of the maximum net asset value test. Section 995-1 of the ITAA 1997 provides direction that the definition of 'connected with' is found at subsection 328-125 of the ITAA 1997 as follows;

…

Direct control of a discretionary trust

An entity (the first entity) controls a discretionary trust if a trustee of the trust acts, or could reasonably be expected to act, in accordance with the directions or wishes of the first entity, its affiliates, or the first entity together with its affiliates.

An entity (the first entity) controls a discretionary trust for an income year if, for any of the 4 income years before that year:

(a) the trustee of the trust paid to, or applied for the benefit of:

(i) the first entity; or

(ii) any of the first entity's affiliates; or

(iii) the first entity and any of its affiliates;

any of the income or capital of the trust; and

(b) the percentage (the control percentage) of the income or capital paid or applied is at least 40% of the total amount of income or capital paid or applied by the trustee for that year.

…

Commissioner may determine that an entity does not control another entity

…

Indirect control of an entity

…

...

Company X is the trustee for the Trust. Beneficiary B is a director of Company X and will occasionally act as Chairman at general meetings. Beneficiary B is also an employee of the Trust.

According to subsection 328-125(3) Beneficiary B will have direct control of the Trust, if Beneficiary B, together with Beneficiary B's affiliates, is able to direct the Trustee to act according to Beneficiary B's wishes.

Company X's constitution states that the Chairman may have a casting vote in a case of equality of votes.

Beneficiary B acts as chairman on occasion.

Beneficiary B is therefore able to control the trust and in accordance with subsection 328-125(3) of the ITAA 1997 is 'connected' with the entity.

Question 4

Is Beneficiary C considered to be 'connected with', an 'affiliate' of, or 'connected with an affiliate' of the trust with respect of section 328-125 of the ITAA 1997?

Summary

Beneficiary C is considered to be connected with the Trust in accordance with section 328-125 of the ITAA 1997.

Detailed reasoning

To qualify for the small business CGT concessions, a taxpayer must satisfy the basic conditions provided in Subdivision 152-A of the ITAA 1997. One of the basic conditions is the maximum net asset value test.

The Maximum Net Assets Value Test, requires the assets to be taken into account where they are owned by the taxpayer, entities controlled by the taxpayer (connected entities) and assets for which the taxpayer has de facto ownership (CGT affiliates). Accordingly, assets held by an agent or nominee of the taxpayer will be taken into account upon the basis they are held by a person that acts in accordance with the taxpayer's directions or wishes.

Subsection 152-15(b) of the ITAA 1997 indicates that any entities connected with you are included in calculating the value of assets for the purposes of the maximum net asset value test. Section 995-1 of the ITAA 1997 provides direction that the definition of 'connected with' is found at subsection 328-125 of the ITAA 1997 as follows;

…

Direct control of a discretionary trust

An entity (the first entity) controls a discretionary trust if a trustee of the trust acts, or could reasonably be expected to act, in accordance with the directions or wishes of the first entity, its affiliates, or the first entity together with its affiliates.

An entity (the first entity) controls a discretionary trust for an income year if, for any of the 4 income years before that year:

(a) the trustee of the trust paid to, or applied for the benefit of:

(i) the first entity; or

(ii) any of the first entity's affiliates; or

(iii) the first entity and any of its affiliates;

any of the income or capital of the trust; and

(b) the percentage (the control percentage) of the income or capital paid or applied is at least 40% of the total amount of income or capital paid or applied by the trustee for that year.

…

Commissioner may determine that an entity does not control another entity

…

Indirect control of an entity

…

...

Company X is the trustee for the Trust. Beneficiary C is a director of Company X and will occasionally act as Chairman at general meetings.

According to subsection 328-125(3) Beneficiary C will have direct control of the Trust, if Beneficiary C, together with Beneficiary C's affiliates, is able to direct the Trustee to act according to Beneficiary C's wishes.

Company X's constitution states that the Chairman may have a casting vote in a case of equality of votes.

Beneficiary C acts as chairman on occasion.

Beneficiary C is therefore able to control the trust and in accordance with subsection 328-125(3) of the ITAA 1997 is 'connected' with the entity.

Question 5

Is Beneficiary D considered to be 'connected with', an 'affiliate' of, or 'connected with an affiliate' of the Trust with respect of section 328-125 of the ITAA 1997?

Summary

Beneficiary D is not considered to be connected with the Trust in accordance with section 328-125 of the ITAA 1997.

Detailed reasoning

To qualify for the small business CGT concessions, a taxpayer must satisfy the basic conditions provided in Subdivision 152-A of the ITAA 1997. One of the basic conditions is the maximum net asset value test.

The Maximum Net Assets Value Test, requires the assets to be taken into account where they are owned by the taxpayer, entities controlled by the taxpayer (connected entities) and assets for which the taxpayer has de facto ownership (CGT affiliates). Accordingly, assets held by an agent or nominee of the taxpayer will be taken into account upon the basis they are held by a person that acts in accordance with the taxpayer's directions or wishes.

Subsection 152-15(b) of the ITAA 1997 indicates that any entities connected with you are included in calculating the value of assets for the purposes of the maximum net asset value test. Section 995-1 of the ITAA 1997 provides direction that the definition of 'connected with' is found at subsection 328-125 of the ITAA 1997 as follows:

…

Direct control of a discretionary trust

An entity (the first entity) controls a discretionary trust if a trustee of the trust acts, or could reasonably be expected to act, in accordance with the directions or wishes of the first entity, its affiliates, or the first entity together with its affiliates.

An entity (the first entity) controls a discretionary trust for an income year if, for any of the 4 income years before that year:

(a) the trustee of the trust paid to, or applied for the benefit of:

(i) the first entity; or

(ii) any of the first entity's affiliates; or

(iii) the first entity and any of its affiliates;

any of the income or capital of the trust; and

(b) the percentage (the control percentage) of the income or capital paid or applied is at least 40% of the total amount of income or capital paid or applied by the trustee for that year.

…

Commissioner may determine that an entity does not control another entity

…

Indirect control of an entity

…

...

Beneficiary D is connected with the Trust if Beneficiary D has authority to direct the trustee to act in accordance with Beneficiary D's wishes regarding the Trust. Beneficiary D will also be considered as connected with the Trust if Beneficiary D's distributions from the Trust are equal to or above the control percentage of 40% for the period.

According to subsection 328-125(3) Beneficiary C will have direct control of the Trust, if Beneficiary C, together with Beneficiary C's affiliates, is able to direct the Trustee to act according to Beneficiary C's wishes.

Beneficiary D does not hold a formal position in Company X, nor in the Trust.

Beneficiary D will only have direct control of the Trust, if Beneficiary D and affiliates, can direct the Trustee to act according to Beneficiary D's wishes.

An Affiliate is described in subsection 328-130(1) of the ITAA 1997 as:

An individual or a company is an affiliate of yours if the individual or company acts, or could reasonable be expected to act, in accordance with your directions or wishes, or in concert with you, in relation to the affairs to the business of the individual or company.

An affiliate of Beneficiary D would be an individual or company that would act in accordance with Beneficiary D's wishes in relation to the Trusts business affairs.

In addition to not holding a company position, Beneficiary D does not contribute to operations or strategic decisions of the Trust. Further, as Beneficiary D doesn't not influence an individual or company in relation to the Trust there is not an affiliate that needs to be considered. Therefore it is considered Beneficiary D does not meet subsection 328-125(3) of the ITAA 1997.

Subsection 328-125(4) of the ITAA 1997 explores connection with an entity if beneficiary distributions exceed a certain percentage.

An entity (the first entity) controls a discretionary trust for an income year if, for any of the 4 income years before that year:

(a) the trustee of the trust paid to, or applied for the benefit of:

(i) the first entity; or

(ii) any of the first entity's affiliates; or

(iii) the first entity and any of its affiliates;

any of the income or capital of the trust; and

(b) the percentage (the control percentage) of the income or capital paid or applied is at least 40% of the total amount of income or capital paid or applied by the trustee for that year.

Trustee Resolutions for Beneficiary D for the previous 4 income years are not greater than 40%.

Subsection 328-125(4) of the ITAA 1997 is not met.

Therefore, the facts provided in Beneficiary D case indicate that there is no connection with the Trust for the purposes of section 328-125 of the ITAA 1997.

Question 6

Summary

A UPE is not a 'liability of the entity related to the assets of the Trust for the purposes of calculating the net value of the CGT assets' of the Trust under section 152-20 (1)(a) of the ITAA 1997.

Detailed reasoning

Eligibility for the small business CGT concessions includes the $6 million maximum net asset value test being met, in accordance with section 152-15 of the ITAA 1997. In satisfying this condition the net value of the CGT assets of the taxpayer and certain related entities must not exceed $6 million just before the relevant CGT event.

The meaning of net value of the CGT assets is provided at section 152-20 of the ITAA 1997. In particular, subsection 152-20(1) details that liabilities that are related to the assets are included in the calculation:

The net value of the CGT assets of an entity is the amount (whether positive, negative or nil) obtained by subtracting from the sum of the market values of those assets the sum of:

(a) the liabilities of the entity that are related to the assets; and

(b)…

This means that the net value of the CGT assets for the Trust will be the amount of the market values of those assets minus the sum of the liabilities (and other factors) of the entity that are related to the assets.

The term liabilities as used in subsection 152-20(1) of the ITAA 1997 to determine the net value of the CGT assets of an entity has its legal meaning. It extends to a legally enforceable debt which is due for payment and to a presently existing obligation to pay either a sum certain or an ascertainable sum.

A definition of 'liability' for the purposes of subsection 152-20(1) if the ITAA 1997 is not provided in taxation legislation, therefore it takes on its ordinary meaning. The Macquarie Dictionary revised 3^rd edition, defines liability as: 'an obligation, especially for payment; debt or pecuniary obligation'.

Liability is also clarified in TD 2007/14, where at paragraph 18 it states:

In the context of subsection 152-20(1), 'liabilities' extend to legally enforceable debts due for payment and to presently existing obligations to pay either a sum certain or ascertainable sums. The term does not extend to contingent liabilities, future obligations or expectancies.

In this case we are examining whether a discretionary trust's UPE's would be included as part of the liability for the purposes of calculating the net value of the CGT asset. Therefore regard to whether a UPE is a legally enforceable debt is considered.

The legal technical meaning of the word 'debt' is defined in Butterworths Australian Legal Dictionary 1997, (Butterworths):

2…A debt is a sum of money which is now payable or will become payable in the future by reason of a present obligation. It is a right which a creditor has to enforce by taking action [emphasis added]

Generally a beneficiary becomes presently entitled to an amount from a trust pursuant to a direct term of the relevant trust deed, or as a result of the trustee of the trust exercising a power under the trust deed to make the beneficiary so entitled (usually by resolution). In situations where the funds to which the beneficiary is made presently entitled continue to be held on trust for that beneficiary until such time as the beneficiary calls for payment, is commonly referred to as a UPE.

Taxation Ruling TR 2010/3 confirms at paragraph 34:

When a beneficiary is presently entitled to an amount from a trust estate, it has an equitable right to that amount. That is, the beneficiary has rights in equity and not, without more, as a result of any debtor-creditor relationship

The key difference between a UPE and a debt is that the UPE does not result in an enforceable obligation imposed by law (as distinct from the rights that attach to a creditor). Rather, the rights of an unpaid beneficiary arise in equity only - and not in law. It is for this reason that an unpaid beneficiary cannot sue for their entitlement.

To 'sue' is 'to bring a civil proceeding against a person'; and a 'civil proceeding' is a proceeding or an action 'commenced in the civil jurisdiction of a court of law' (both definition from Butterworths).

A beneficiary's cause of action is in the equitable jurisdiction of a court (a beneficiary's interest not being recognised at law). While the rules of law and equity may be administered concurrently in the various State Supreme courts in Australia, a clear distinction between equitable and legal causes of action remains. Case law supports this also in the Federal Court decision of Euroasian Holding Pty Ltd v Ron Diamond Plumbing Pty Ltd (in liquidation) 1996 64 FCR 147 where it was confirmed that a UPE was not a debt.

The resolutions of the Trust have been provided for the years ended 30 June 2009-2012 and clearly specify the distributions to the beneficiaries. Where these distributions represent UPE's they are not regarded as an enforceable debt and are not considered liabilities when calculating the net value of CGT assets.

Therefore, for the reasons provided, the Trust's UPE's are not considered liabilities of the entity related to the assets of the Trust for the purposes of calculating the net value of the CGT assets of the Trust under section 152-20 (1)(a) of the ITAA 1997.

Copyright notice

© Australian Taxation Office for the Commonwealth of Australia

You are free to copy, adapt, modify, transmit and distribute material on this website as you wish (but not in any way that suggests the ATO or the Commonwealth endorses you or any of your services or products).