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Ruling

Subject: capital gains tax on disposal of shares

Question and answer

Are you liable for capital gains tax in accordance with Part 3-1 and Part 3-3 of the Income Tax Assessment Act 1997 (ITAA 1997) on the disposal of your shares in Company X?

Yes.

This ruling applies for the following period:

Year ended 30 June 2011

The scheme commences on:

1 July 2010

Relevant facts and circumstances

You and your spouse jointly owned shares in Company X.

You held these shares as a direct result of your supply of produce to Company X.

You had supplied Company X for many years prior to its conversion from an association (Association X).

You had been members of Association X prior to the change of its rules. After the change of its rules, which occurred after 19 September 1985, you were issued with one new share in Association X and subsequently additional shares over a period of time.

These shares subsequently became shares in Company X. You and your spouse elected that section 160ZZP of the ITAA 1936 shall apply and no amount was brought to account in that tax year.

You and your spouse sold the shares in the 2011 financial year and recorded a capital gain in your income tax returns for that year.

Relevant legislative provisions

Income Tax Assessment Act 1936 Part IIIA

Income Tax Assessment Act 1936 Division 17 of Part IIIA

Income Tax Assessment Act 1936 Section 160A

Income Tax Assessment Act 1936 Section 160M

Income Tax Assessment Act 1936 Section 160R

Income Tax Assessment Act 1936 Section 160U

Income Tax Assessment Act 1936 Section 160ZD

Income Tax Assessment Act 1936 Section 160ZYF

Income Tax Assessment Act 1936 Section 160ZZP

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 Subdivision 115-A

Income Tax Assessment Act 1997 Subdivision 124-E

Reasons for decision

Summary

In your circumstances, it is considered that you acquired the new share in Association X at the time the Board allotted the new share within a meeting of the Board of Directors of Association X which occurred after 19 September 1985.

It is considered that the new share and additional shares in Association X are CGT assets for the purposes of Part IIIA of the ITAA 1936 and Parts 3-1 and 3-3 of the ITAA 1997.

In consideration of your circumstances, you have acquired those new and additional shares after 19 September 1985. Therefore the shares are new CGT assets for the purposes of Part IIIA of the ITAA 1936 and Parts 3-1 and 3-3 of the ITAA 1997.

When your shares in Association X were exchanged for shares in Company X you elected that a rollover in accordance with section 160ZZP of the ITAA 1936 apply to defer the capital gain.

Therefore you are liable for capital gains tax in accordance with Part 3-1 and Part 3-3 of the ITAA 1997 on the disposal of your shares in Company X.

As you have owned the shares for more than 12 months you are eligible to apply a discount percentage of 50% to the gain.

Detailed reasoning

The capital gains tax framework was introduced in 1985 and the legislation received Royal Assent on 24 June 1986. The date of effect was 20 September 1985. Assets acquired before 20 September 1985 are referred to as pre-CGT assets. Assets acquired after 19 September are CGT assets.

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.

Generally a capital gain or capital loss is made where a 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.

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.

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 which occurred after 19 September 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.

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 Commissioner's 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.

Discount capital gain

Subdivision 115-A of the ITAA 1997 contains the provisions for a discount capital gain on the disposal of a CGT asset. Under this subdivision an individual who has owned the CGT asset for more than 12 months may apply a discount percentage of 50% to the gain made.

Application of the law

Shares in the association

Association X was registered under the PPCAA, which allows it to be registered as a class of association 'having a capital divided into shares and with limited liability' under section 7 of the PPCAA.

Accordingly the original rules of Association X 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 is defined to be a CGT asset 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 Association X, each member of Association X 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 Association X 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 of Association X which occurred after 19 September 1985.

As your new share allotted by the Board of Directors of Association X resulted in the redemption or cancellation of your old share, it is considered that there has been a change in ownership of your old share. Therefore, your old share is deemed to have been disposed of under paragraph 160M(3)(c) of the ITAA 1936 after 19 September 1985.

Therefore, as you acquired the new share after 19 September 1985, the 'new' share in Association X, where that new share was allotted in replacement of your 'old' share within a meeting of the Board of Directors of Association X, 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.

In consideration of your circumstances, you have acquired your share in Association X after 19 September 1985. Therefore your share is 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.

Conversion of the association to a company

Your shares in Association X were exchanged for shares in Company X.

At that time you elected that a capital gains tax rollover in accordance with section 160ZZP of the ITAA 1936 shall apply to defer any capital gain on the disposal of your shares in Association X.

Company X provided members with advice concerning the application of capital gains tax to any sale or disposal of shares in Company X in the future. This information contained a valuation of the shares at the time the new shares in Association X were issued after the change to its rules, to assist shareholders with the calculation of the cost base.

Conclusion

In your circumstances, it is considered that you acquired the new share in Association X at the time the Board allotted the new share within a meeting of the Board of Directors of Association X after 19 September 1985.

It is considered that the new share and additional shares in Association X are CGT assets for the purposes of Part IIIA of the ITAA 1936 and Parts 3-1 and 3-3 of the ITAA 1997.

In consideration of your circumstances, you have acquired those new and additional shares after 19 September 1985. Therefore the shares are new CGT assets for the purposes of Part IIIA of the ITAA 1936 and Parts 3-1 and 3-3 of the ITAA 1997.

When your shares in Association X were exchanged for shares in Company X you elected that a rollover in accordance with section 160ZZP of the ITAA 1936 apply to defer the capital gain.

Therefore you are liable for capital gains tax in accordance with Part 3-1 and Part 3-3 of the ITAA 1997 on the disposal of your shares in Company X.

As you have owned the shares for more than 12 months you are eligible to apply a discount percentage of 50% to the gain.

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