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Edited version of your written advice

Authorisation Number: 1012707389415

Ruling

Subject: CGT, consolidation and Part IVA

Question 1

Will the proposed restructure of Coy A and Coy B cause any Capital Gains Tax (CGT) events to happen?

Answer

Yes

Question 2

Will the proposed issue of shares in Coy B and the entering into of the Deed cause CGT event D1 to happen?

Answer

Yes

Question 3

Will the Commissioner seek to apply Part IVA of the Income Tax Assessment 1936 (ITAA 1936) to the identified Scheme?

Answer

No

This ruling applies for the following period:

Year ending 30 June 2015

The scheme commences on:

01 July 2014

Relevant facts and circumstances

Coy A was registered as a company in 199X. AB holds all of the shares in Coy A.

Coy A owns IP.

Coy A wants to raise capital from investors to commercialise the IP.

Coy A has proposed investors

The proposed investors have requested that ownership of the IP be transferred to a new company.

AB has proposed the use of Coy B.

AB holds all of the shares in Coy B.

Coy B has nominal cash assets and no or nominal liabilities.

The proposed restructure involves the following steps:

The shareholders of Coy B will execute an Agreement that will govern their relationship in relation to Coy B

The shareholders of Coy B will also execute a Deed. The Deed will include a restrictive covenant.

Relevant legislative provisions

Section 104-35 of the Income Tax Assessment Act 1997

Income Tax Assessment Act 1997 Section 104-510,

Income Tax Assessment Act 1997 Section 104-520,

Income Tax Assessment Act 1997 Section 116-20,

Income Tax Assessment Act 1997 Section 701-1,

Income Tax Assessment Act 1997 Section 703-50,

Income Tax Assessment Act 1997 Section 705-25,

Income Tax Assessment Act 1997 Section 705-60,

Income Tax Assessment Act 1997 Section 711-20,

Income Tax Assessment Act 1936 Section 177A,

Income Tax Assessment Act 1936 Section 177C and

Income Tax Assessment Act 1936 Section 177CB.

Reasons for decision

Question 1

Division 104 of the Income Tax Assessment Act 1997 (ITAA 1997) sets out all of the CGT events for which an entity can make a capital gain or loss.

To determine whether any CGT events happen as a consequence of the proposed restructure of Coy A and Coy B it is necessary to consider the acts that make up the proposed restructure.

The restructure contemplates the following actions:

Transfer of the share in Coy B

It is accepted by the applicant that the transfer of the share in Coy B will cause CGT event A1 to happen, with the capital gain or loss arising to AB.

Tax consolidate Coy A and Coy B

Subdivision 104-L of the ITAA 1997 contains a number of CGT events that relate to tax consolidated groups. CGT events L1, L2, L3, L4 and L8 may apply in circumstances where an entity becomes a subsidiary member of a consolidated group. Based on the facts and circumstances, CGT event L3 is particularly relevant to the proposed restructure.

Subsection 104-510(1) of the ITAA 1997 provides that CGT event L3 happens if:

Subsection 705-25(5) of the ITAA 1997 provides that a 'retained cost base asset' includes:

Subsection 705-25(2) of the ITAA 1997 states that the tax cost setting amount for Australia currency is equal to the amount of the Australian currency:

        If the retained cost base asset is [Australian currency] … and is not covered by another subsection of this section, its tax cost setting amount is equal to the amount of the Australian Currency concerned.

  

Section 705-60 of the ITAA 1997 provides the following formula for determining a joined group's allocable cost amount for the joining entity (all legislative references in the table are to the ITAA 1997):

You advise that at the time Coy B will become a subsidiary member of the consolidated group its only asset will be cash; a retained cost base asset (Australian currency) with a value equal to the amount of the cash. You also advise that it will have either no or nominal liabilities. If the tax cost setting amount for the cash exceeds the group's allocable cost amount for Coy B, the head company will make a capital gain equal to the excess. If the sum of the cash does not exceed the group's allocable cost amount for Coy B, the head company will not make a capital gain or loss from this CGT event. The time of the event will be just after Coy B becomes a subsidiary member of the tax consolidated group.

Coy A transfers IP it owns to Coy B

Subsection 701-1(1) of the ITAA 1997 contains the single entity rule and states:

Taxation Ruling TR 2004/11 Income tax: consolidation: the meaning and application of the single entity rule in Part 3-90 of the Income Tax Assessment Act 1997 provides the following explanation of the income tax consequences of the single entity rule (SER):

The transfer of the IP from Coy A to Coy B will be a dealing between members of the same consolidated group (an intra-group dealing). As such, the transfer will not be recognised for any entity within the group (there will be no CGT event).

Coy B exits the tax consolidated group

Subdivision 104-L of the ITAA 1997 also provides a CGT event (event L5) that may occur in circumstances where an entity ceases to be a subsidiary member of a tax consolidated group.

Subsection 104-520(1) of the ITAA 1997 provides that CGT event L5 happens if:

Subsection 711-20(1) of the ITAA 1997 provides the following formula for determining the old group's allocable cost amount for the leaving entity (all legislative references in the table are to the ITAA 1997):

If, after going through the above formula, Coy B has a negative allocable cost amount, the head company will make a capital gain equal to that amount. If the allocable cost amount for Coy B is nil or positive, the head company will not make a capital gain or loss. The time of the event will be when Coy B ceases to be a subsidiary member of the group

Question 2

Subsection 104-35 (1) of the ITAA 1997 states:

The shareholders of Coy B will execute a Deed (the Deed) that sets out covenants relating to Coy B. One of the covenants will prohibit each of the parties from competing with Coy B. This restrictive covenant will create a contractual right between each party to the Deed (each party will contract with the other parties not to compete with Coy B), and will cause CGT event D1 to happen for each party to the Deed.

The time of the event will be when the Deed is entered into.

Subsection 104-35(3) provides that a capital gain is made if the capital proceeds from creating the right are more than the incidental costs incurred that relate to the event, and a capital loss is made if the capital proceeds are less than the incidental costs incurred.

'Capital proceeds' is defined in subsection 116-20(1) of the ITAA 1997 as follows:

The parties to the deed will not receive money in respect to the restrictive covenant. As such, it is necessary to consider the market value of any other property received by the parties in respect of the CGT D1 event. The consideration to be given by each party to the Deed is considered to be the rights forfeited by each party under the restrictive covenant. However, not all rights are considered to be property. Generally, a right will be property where it is capable of assignment. Personal rights, such as rights under a restrictive covenant, are not capable of assignment, and are not propriety rights. Therefore, no party to the Deed will receive property in respect to the CGT D1 event, and there will be no capital proceeds giving rise to a capital gain or loss.

Question 3

Part IVA of the ITAA 1936 will apply where:

Scheme

Section 177A of the ITAA 1936 provides the following meaning of 'scheme':

The proposed restructure includes the following steps:

These steps in the proposed restructure are considered to be a scheme under section 177A of the ITAA 1936 and the relevant scheme for the purposes of section 177D.

Tax benefit in connection with a scheme

Subsection 177C(1) of the ITAA 1936 provides that a tax benefit obtained by a taxpayer in connection with a scheme includes:

In deciding whether an amount 'would have been included' or 'might reasonably be expected to be included' in the assessable income of the taxpayer had the scheme not been entered into or carried out, subsection 177CB(1) of ITAA 1936 requires consideration be given to the following:

In the present case, the transfer of the share in Coy B to Coy A and the election by Coy A to form a consolidated group with Coy B will enable Coy A to transfer the IP to Coy B without causing a CGT event A1 (and the likely capital gain) to happen.

If it is postulated (option 1) in accordance with subsection177CB(2) that Coy A does not carry out the scheme events, an assessable CGT event would not happen as there would be no disposal of the IP to Coy B. There would be no tax effect (ie no amount would be included in the assessable income of Coy A).

Alternatively (option 2), Coy A could retain ownership of the IP and undertake the commercialisation of the IP itself by means of debt capital. In which case there would be no tax effect, ie, no capital gain would be included in Coy A's assessable income. However, taking into account subsection 177CB(4), you advise that the substance and objective or result of the scheme is to enable Coy A to commercialise the IP that it owns by means of capital from investors. This postulate is not a reasonable alternative given that outcome would not be achieved.

Another alternative (option 3), taking into account subsection 177CB(4), would involve AB still transferring their shareholding in Coy B to Coy A, but not using the 100% ownership to consolidate. Rather Coy A would merely transfer the IP it owns to Coy B in consideration for Coy B issuing shares to Coy A, with Coy B then also issuing shares to the proposed investors. This would achieve both the scheme's substance and the taxpayer's result by enabling Coy A to commercialise the IP by means of the investors who have agreed to contribute capital. The consequent assessable capital gain to Coy A (from the disposal of the IP to Coy B) would not be relevant (subparagraph 177CB(4)(b)).

Perhaps a more reasonable alternative (option 4) that would achieve the substance and outcomes of the scheme (ie Coy A commercialising the IP by means of capital injection by the proposed investors) would involve Coy A and the proposed investors setting up a new company. Coy A providing the IP as capital and the investors providing cash as capital (the shareholding of each would be commensurate to their capital contribution as under the scheme). Again, the consequent assessable capital gain to Coy A, from disposing of the IP to the new company, would not be relevant.

The tax benefit for the purpose of section 177C of the ITAA 1936 will be the tax free capital gain to Coy A by virtue of Coy A's election to form a consolidated group with Coy B, and the consequent application of the single entity rule.

Paragraph 177C(2)(a)(i) of the ITAA 1936 provides an exclusion to obtaining a tax benefit where the tax benefit relates to the non-inclusion of an amount in assessable income, and the non-inclusion is 'attributable' to an election being made as provided for under the ITAA 1936 or ITAA 1997. The omission of an amount from the assessable income of a member of a consolidated group can be attributed to the election to consolidate. The choice to consolidate is the direct cause of these effects of the statutory fictions of the single entity rule.

However, the exclusion will only apply where the scheme was not entered into or carried out for the purpose of creating the circumstance or state of affairs needed to enable the election to be made (subparagraph 177C(2)(a)(ii)). To this end the Consolidations Reference Manual (C9-1-220 Application of Part IVA to elections to consolidate) provides (at p. 4-5):

Broadly speaking, then, the circumstances to which subparagraph (ii) [of paragraph 177C(2)(a)] might apply are causing a company to be the beneficial owner of all the shares in at least one other company on a particular day, and for its own shares not to be wholly owned beneficially by another resident company on that date.

…

Likewise, a company that had no subsidiaries at all, and that acquired a subsidiary dominantly to enable it to make an election to consolidate, or which arranged for itself to be acquired by a head company to enable that head company to make an election to consolidate, might have entered into and carried out a scheme to which Part IVA could apply, since these schemes bring into existence the state of affairs which must exist for the choice to be available.

For subparagraph 177C(2)(a)(ii) to apply to the proposed scheme, the scheme must be entered into or carried out for the purpose of enabling the election to consolidate to be made.

You advise that the reason for the proposed scheme is to enable Coy A to commercialise the IP that it owns by means of capital from investors; Coy A has investors who have agreed to invest in IP, the investors want to invest in a new company and want the IP to be transferred to such a company, Coy B meets the requirements of the investors.

Although the proposed scheme will involve Coy A acquiring a subsidiary (Coy B) to enable it to form a consolidated group, it is considered that the purpose for the scheme is to enable Coy A to raise capital from investors, rather than to enable it to make an election to consolidate.

As the proposed scheme will not be entered into for the purpose of enabling an election to be made, paragraph 177C(2)(a)(i) will apply, with the effect that there will be no tax benefit obtained in connection with the scheme.

Conclusion

Coy A will not obtain a tax benefit in connection with the scheme. As such, Part IVA will not apply to the scheme.

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