Edited version of your written advice

Authorisation Number: 1012721334652

Ruling

Subject: Capital gains tax (CGT) status of asset - majority underlying interest

This ruling applies to

X Pty Ltd

Issue 1

Question 1

Would Division 149 of the Income Tax Assessment Act 1997 (ITAA 1997) convert the pre-CGT status of the relevant assets of X Pty Ltd, i.e., the shares in Y Pty Ltd to a post CGT asset?

Answer

No

Question 2

If so, will the Commissioner exercise his discretion under subsection 149-30(2) of the ITAA 1997 to treat the relevant asset as a pre-CGT asset?

Answer

Not applicable.

Question 3

If the answer to either of the above question is yes, as a result, do the interests in the subsidiary companies of Y Pty Ltd retain their pre-CGT status also?

Answer

Yes.

This ruling applies for the following periods

Pre 20 September 1985 to 30 June 20XX

The scheme commences on

Pre 20 September 1985

Relevant facts and circumstances

The ownership profile of X Pty Ltd is set out in Appendix A of the application as follows:

X Pty Ltd has issued different classes of shares and in particular issued:

• A class shares that are held by the Child 2 Fund and the Child 1 Fund

• B class shares are held by the Child 2 Fund and the Child 2 Fund

• C class shares are held by Child 2 and

• D class shares are held by Child 1

The shares held by Child 2 and Child 1 amount to 49% of the underlying interest in the CGT assets of X Pty Ltd. These shares were acquired in pre-CGT.

All classes of shares held by the shareholders (as set out in the ownership profile) have the same rights. There have been no variations to the rights attaching to each class of share.

Upon the death of parent 1 in mid-1990s,their Last Will and Testament established Child 2 and Child 1 discretionary testamentary trusts (also known as 'the Child 2 Fund' and 'the Child 1 Fund' and collectively the Funds), to which their shares (approximately 25.50%) in X Pty Ltd were transferred to the Funds, 13 shares each.

Upon the death of parent 2 in late 1990s, their Last Will and Testament provided that their shares (approximately 25.5%) in X Pty Ltd were to be transferred to the Funds, 13 shares each.

The respective trustee of the Funds must pay or apply (ultimately) the capital and income to the children, their children and their widow or widowers, corporations where any share is owned by the beneficiary and any trust or settlement under which any of the beneficiaries have an interest whether absolutely expectant or contingent as per parent 2 and parent 1 Last Will and Testament.

Both Funds have been created and administered for the benefit of the same family as follows:

• the trustee of the Child 1 Fund has always administered the Fund for the benefit of the child's family and related entities

• the trustee of Child 2 Fund has always administered the Fund for the benefit of the child's family and related entities.

Y Pty Ltd is a wholly owned subsidiary of X Pty Ltd. X Pty Ltd's shareholding consists of 100 pre-CGT shares and 4 post-CGT shares. X Pty Ltd acquired the 4 post-CGT shares from:

• Child 2 Fund (being 2 shares); and

• Child 1 Fund (being 2 shares).

The group structure is as follows:

• X Pty Ltd is owned by Child 1 (25 D class shares comprising of 24.5%), Child 2 (25 C class shares comprising of 24.5%), Child 2 Fund (13 A class and 13 B class shares comprising of 25.5%) and Child 1 Fund (13 class A and 13 class B shares comprising of 25.5%)

• X Pty Ltd wholly owns Y Pty Ltd

• Y Pty Ltd wholly owns W Pty Ltd and Z Pty Ltd.

Relevant legislative provisions

Income Tax Assessment Act 1936 section 160ZZS

Income Tax Assessment Act 1997 section 149-15

Income Tax Assessment Act 1997 section 149-30

Reasons for decision

Summary

Division 149 of the ITAA 1997 would not convert the pre-CGT status of the relevant assets of X Pty Ltd, i.e., the shares in Y Pty Ltd to a post CGT asset.

The interests in the subsidiary companies of Y Pty Ltd would also retain their pre-CGT status.

Detailed reasoning

The provisions of Subdivision 149-B of the ITAA 1997 determines when a CGT asset of an entity stops being a pre-CGT asset (unless the entity is a public entity listed in section 149-50 of the ITAA 1997). This happens at the earliest time, according to subsection 149-30(1) of the ITAA 1997, when the majority underlying interests in the asset were not held by 'ultimate owner' who held the majority underlying interests in the asset immediately before 20 September 1985.

Majority underlying interests is a defined term under subsection 995-1(1) of the ITAA 1997 and has the meaning given by section 149-15 of the ITAA 1997.

According to section 149-15 of the ITAA 1997, majority underlying interests in a CGT asset consists of

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

(b) 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.

According to subsection 149-15(2) of the ITAA 1997

An underlying interest in a CGT asset is a beneficial interest that an ultimate owner has (whether directly or indirectly) in the asset or in any ordinary income that may be derived from the asset.

According to subsection 149-15(3) of the ITAA 1997, an ultimate owner can include, among others, an individual.

The "majority underlying interest" and the "underlying interest" include both direct and indirect beneficial interest of the ultimate owners. According to subsections 149-15(4) and (5) of the ITAA 1997, an ultimate owner has an indirect beneficial interest in a CGT asset of another entity, which is not the ultimate owner, if they would receive for their own benefit any of the capital of the other entity is the:

(a) other entity were to distribute any of its capital or a dividend; and

(b) capital and/or dividend was then successively distributed by each entity interposed between the other entity and the ultimate owner.

The expression, 'beneficial interests', as used in the definition of 'majority underlying interests,' is not defined. At general law, a shareholder does not have any legal or equitable interest in the asset of a company. Similarly, beneficiaries in a discretionary trust do not have an interest, either individually or collectively, in the assets or the income of a trust. This situation is addressed in ATO Interpretive Decision 2003/778:

Under ordinary legal concepts, where there is a discretionary trust deed, no beneficiary is entitled to income or capital of the trust until the trustee exercises its discretion to distribute income or to make an appointment of capital. Because the beneficiary of a discretionary trust does not hold an interest in any asset of the trust or in the ordinary income derived from the asset until the trustee's discretion is exercised, it would not be possible for a discretionary trust to satisfy the continuing majority underlying interests test set out in subsection 149-30(1) of the ITAA 1997.

Taxation Ruling IT 2340 reflects on an approach of looking through interposed entities to determine which natural persons hold the beneficial interests for the purposes of section 160ZZS of the Income Tax Assessment Act 1936 (ITAA 1936), which preceded Division 149 of the ITAA 1997, is reflected in Taxation Ruling IT 2340. Among other issues, IT 2340 deals with questions regarding the application of section 160ZZS of the ITAA 1936 'to assets held by trustees of family trusts where the trustees are vested with discretionary powers as to distributions from the trusts.

….

Taxation Ruling IT 2340 correctly reflects the position that section 160ZZS of the ITAA 1936, by its terms, necessarily supplants normal legal concepts of interests in assets. For the purposes of section 160ZZS, a beneficiary of a discretionary trust is treated as having a beneficial interest in the trust's assets. Likewise, a shareholder is treated for the purposes of section 160ZZS of the ITAA 1936 as having a beneficial interest in the company' assets.'

Under this approach the Commissioner can 'look through' an entity to determine who are the natural persons who hold beneficial interests in assets, as stated in paragraph 2 of Income Tax Ruling IT 2340:

The terms "underlying interest" and "majority underlying interests", on the basis of which the provision operates, have the same meanings as they have in Subdivision G of Division 3 of Part III of the Act - which deals with the income tax treatment of interest in relation to "negatively geared" investments in rental property. In both cases (and like other provisions of the Act concerned with the measurement of ownership interests) underlying interests in relation to the assets concerned mean beneficial interests held by natural persons. The clear policy of the law thus permits and requires that, for the purposes of the relevant provisions, chains of companies, partnerships and trusts are to be "looked through" in order to determine whether there has been a change in the effective interests of natural persons in the assets.

IT 2340 sets out the Commissioner's approach in respect of 'looking through' discretionary family trusts to determine whether majority underlying interests have been maintained in the assets of the trust, as follows:

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.

In the present case, until the passing of parent 1, the four members of the same family, namely parent 1 (being the owner of 25.5% of the shares), parent 2 (being the owner of 25.5% of the shares), Child 2 (being the owner of 24.5% of the shares) and Child 1 (being the owner of 24.5% of the shares), held 100% ownership of shares in X Pty Ltd that were pre-CGT. So the family held the majority underlying interest in the CGT asset as per section 149-15 of the ITAA 1997. These four members of the family were the ultimate owner who held direct beneficial interest in X Pty Ltd: subsection 149-15(3) of the ITAA 1997.

When parent 1 passed away in mid 1990s, their shares went in equal proportion to the Funds established for their two children through testamentary trusts, namely Child 2 Fund and Child 1 Fund (together as Funds) as per the Last Will and Testament of parent 1.

Again, when parent 2 passed away in late 1990s, their shares went in equal proportion to those Funds for the benefit of Child 2 and Child 1 in equal proportion as per the Last Will and Testament of parent 2.

Subsection 149-30(3) and 149-30(4) of the ITAA 1997 provides that, if an ultimate owner (the new owner) has acquired an interest in an asset because it was transferred to the new owner because of the death of a person (former owner), the new owner is treated as having held the underlying interest of the former owner for the period the former owner held them.

In this case, if the 51% of the parent's shares in X Pty Ltd went directly to the children, they would have, as per subsections 149-30(3) and 149-30(4) of the ITAA 1997, considered as having held the underlying interest of their parents shares for the period for which it was held by the parents, and hence the shares would maintain its pre-CGT status.

However, since the 51% of the shares went to the Funds to be administered by the trustee of the Funds, and since the children, are not entitled to the shares or income from the shares until the trustees exercise their discretion, question arises as to whether the majority underlying interest in X Pty Ltd would continue to be held by the children.

According to the Last Will and Testament of the parents, the respective trustees of the Funds must pay or apply the capital and income to the beneficiaries stated in the Last Will and Testament of the parents, namely the children, their children and their widow or widowers, corporations where any share is owned by the beneficiary and any trust or settlement under which any of the beneficiaries have an interest whether absolutely expectant or contingent.

As discussed above with reference of the ATOID 2003/778 and IT 2340, by application of the 'look through' approach, it is apparent that although the respective shares of the parents in X Pty Ltd went to the Funds, majority underlying interest of ultimate owners in X Pty Ltd did not change as the trustees of the Funds are to exercise their discretionary power for the benefit of the same family. In other words, the beneficial interest of the ultimate owners of same family is maintained despite the shares being received via a testamentary trust.

Therefore, subsection 149-30(1) of the ITAA 1997 will not trigger to convert the pre-CGT assets of X Pty Ltd to post CGT.

Y Pty Ltd is wholly owned by X Pty Ltd. The same ultimate owners of X Pty Ltd are the ultimate owners of Y Pty Ltd and have the beneficial interest in the CGT asset or income derived from the CGT asset of Y Pty Ltd.

Since Y Pty Ltd is wholly owned by X Pty Ltd, all the capital and or dividend of former is distributed to X Pty Ltd which in turn distributes such capital and/or dividend either directly to the children or indirectly through the Funds to the beneficiaries of the Funds.

Therefore, following the "look through" approach, Division 149 of the ITAA 1997 would not convert the pre-CGT status of the relevant assets of X Pty Ltd, namely the shares in Y Pty Ltd to a post CGT asset.

W Pty Ltd and Z Pty Ltd (together as subsidiaries) are wholly owned subsidiaries of Y Pty Ltd. All the capital and/or dividend of the subsidiaries are to be distributed entirely to Y Pty Ltd which in turn distributes only to X Pty Ltd. X Pty Ltd, in its turn, only distributes such capital and/or dividend to the ultimate owners of X Pty Ltd holding the majority underlying interest, either directly or through the Funds. Since the ultimate owners of X Pty Ltd maintained the pre-CGT status of their majority underlying interests, irrespective of the interposed entities in the chain between those subsidiaries and the ultimate owners, the subsidiaries would maintain its pre-CGT status.

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