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Ruling

Subject: Majority underlying interests - pre-CGT asset

Question 1

Will the Commissioner exercise his discretion under subsection 149-30(2) of the Income Tax Assessment Act 1997 (ITAA 1997), to assume that the majority underlying interests in the assets of the company has not changed as a result of the vesting of the trust and the transfer of the shares in the company to the beneficiaries?

Answer

Yes

Question 2

Will the assets held by the company that were acquired prior to 20 September 1985 retain their pre-CGT status?

Answer

Yes

This ruling applies for the following period:

Year ended 30 June 2012

The scheme commenced on:

1 July 2011

Relevant facts and circumstances

The trust

The trust was settled by deed. The trust deed was clarified by a supplement deed and varied by a deed of variation.

The main beneficiaries of the trust were at all times the children of X. The spouses and children of X's children are also listed as beneficiaries.

X had four children being B, C, D and E. The children's other parent was Y.

During the existence of the trust, the income of the trust was generally distributed to some or all of the four children or accumulated.

As per the trust deed, the trust vested. The shares in the company held by the trust passed in equal shares to the four children as outlined further below.

The company

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

The trust

· X

· Y

The A class and B class shares have the same voting rights, rights to income and rights to capital. They are the same rights that would normally be attached to shares referred to as normal shares.

The preference shares have a right to a set dividend each year and no voting rights. They also have a right on winding up to rank in priority to all other classes of shares for the payment of all arrears of dividend payment and for the repayment of the amount of capital paid up, without the right to otherwise participate in the profit or assets of the company.

The company undertook a one for two share split. There was no change to the total amount of share capital at this point. Following the share split the shareholders of the company remained the same.

Following the vesting of the trust, each of X's children received an equal share of the shares held by the trust. Accordingly, following the vesting of the trust, the shareholders of the company were as follows:

· B

· C

· D

· E

· X

· Y

Y died. Pursuant to the terms of their will, some of their A class shares in the company were transferred to B and the remaining of their A class shares were transferred in equal shares to three testamentary trusts, one for each of their other three children. Additionally their preference shares were transferred in equal shares to B and C.

X died. Pursuant to the terms of their will, D and E each received an equal share of her preference shares in the company.

Therefore, as a result of the deaths of Y and X, the current shareholders of the company are as follows:

· B

· C

· C Testamentary Trust

· D

· D Testamentary Trust

· E

· E Testamentary Trust

The company holds shares which it acquired prior to 20 September 1985.

Relevant legislative provisions

Income Tax Assessment Act 1997 Division 149

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

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

Income Tax Assessment Act 1997 Subsection 149-30(2)

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

Reasons for decision

Division 149 of the Income Tax Assessment Act 1997 (ITAA 1997) outlines the rules which govern when an asset acquired by a taxpayer before 20 September 1985 is treated as being acquired after that date for capital gains tax (CGT) purposes.

Under subsection 149-30(1) of the ITAA 1997, a pre-CGT asset of a non-public entity stops being a pre-CGT asset at the earliest time when the majority underlying interest in the asset were not had by the ultimate owners who had the majority underlying interests in the asset immediately before 20 September 1985.

Subsection 149-15(1) of the ITAA 1997 provides that majority underlying interests in a CGT asset consists of:

· more than 50% of the beneficial interests that ultimate owners have (whether directly or indirectly) in the asset; and

· more than 50% of the beneficial interests that ultimate owners have (whether directly or indirectly) in any ordinary income that may be derived from the asset.

Share split

Taxation Determination TD 2000/10 discusses the CGT consequences if a company converts its shares into a larger number of shares. TD 2000/10 states that when a company converts its shares into a larger number of shares, there is no change in beneficial ownership where:

· the original shares are not cancelled or redeemed in terms of the Corporations Law

· there is no change to the total amount of share capital of the company; and

· the proportion of equity owned by each shareholder is maintained.

The company undertook a one for two share split, doubling the total number of shares. However at this point, there was no change in the total amount of share equity and the proportion of equity owned by each shareholder was maintained. It follows that as a result of the share split, there was no change in beneficial ownership of the shares. Accordingly, the share split will not change the majority underlying interest of the company.

Vesting of the trust

A beneficiary in a discretionary trust, such as the trust, could not be said to have a beneficial interest in the income or assets of the trust, in the light of cases such as Gartside v IRC [1968] AC 553 and Re Weir's Settlement MacPherson & anor v. IRC [1970] 1 All ER 297.

However, paragraphs 5 to 7 of Taxation Ruling IT 2340 discuss what happens in respect of non-fixed family trusts and the application of the former section 160ZZS of the Income Tax Assessment Act 1936 (now Division 149 of the ITAA 1997):

5. In relation to what are generally referred to as discretionary trusts, i.e., family trusts, the trustees of which have discretionary powers as to the distribution of trust income or property to beneficiaries, in considering the question of whether majority underlying interests have been maintained in the assets of the trust it will be relevant to take into account the way in which the discretionary powers of the trustees are in fact exercised.

6. Where a trustee continues to administer a trust for the benefit of members of a particular family, for example, it will not bring section 160ZZS into application merely because distributions to family members who are beneficiaries are made in such amounts and to such of those beneficiaries as the trustee determines in the exercise of his discretion.

7. In such a case the Commissioner would, in terms of sub-section 160ZZS(1), find it reasonable to assume that for all practical purposes the majority underlying interests in the trust assets have not changed. That is consistent with the role of the section to close potential avenues for avoidance of tax in cases where there is a substantial change in underlying ownership of assets and the legislative guidance contained in Subdivision G of Division 3 of Part III of the Act. On that basis, trust assets acquired by the trustee before 20 September 1985 would remain outside the scope of the capital gains and losses provisions of the Act.'

The trust acquired shares in the company prior to 20 September 1985. Distributions of income of the trust have been made to X's four children in accordance with the trust deed. Additionally, no amendment of the trust deed had the practical effect of a change of 50% or more in the underlying interests in the assets of that trust. When the trust vested X's four children became presently entitled to the shares in equal proportions.

Taking the principles contained in IT 2340 into account, the beneficial interest in the company's shares is taken to have not changed as a result of the vesting of the trust. Therefore, the vesting of the trust will not change the majority underlying interests in the company's assets.

Changes to shareholdings following the death of a shareholder

Subsection 149-30(4) of the ITAA 1997 provides that if an ultimate owner (new owner) has acquired an interest in an asset which is transferred to them as a result 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 owner will stand in the shoes of the former owners.

Y died, and as a result of their death B and three testamentary trusts received their A class shares in the company. Additionally, Y's preference shares were transferred to B and C as a result of Y's death. Subsequently, X died and as a result of their death their preference shares were transferred to D and E.

In accordance with section 149-30 of the ITAA 1997, the changes in shareholdings that occurred following the deaths of Y and X will not change the majority underlying interest in the company's assets as the new owners will be taken to stand in the shoes of the former owners.

Conclusion

As it is taken that the majority underlying interests have not changed as a result of any of the above events, assets held by the company that were acquired prior to 20 September 1985 will retain their pre-CGT status subsequent to the trust vesting and the deaths of Y and X.

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