Edited version of your written advice

Authorisation Number: 1012810116319

Ruling

Subject: Convertible Preference Shares

Question 1

After the Proposed Amendments to the terms of the Convertible Preference Shares (CPS) issued by Company B, will the CPS continue to be equity interests as defined in section 974-70 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes

Question 2

Will Company A make a capital gain from the happening of a CGT event as a result of the Proposed Amendments to the terms of the CPS?

Answer

No

Question 3

Will any capital gain or capital loss that Company A might otherwise make from converting the CPS into ordinary shares in Company B be disregarded pursuant to Subdivision 130-C of the ITAA 1997?

Answer

Yes

Question 4

Will CGT event K8 happen for Company A as a result of the Proposed Amendments and rights offer?

Answer

No

Question 5

Will the Proposed Amendments to the terms, and Conversion of the CPS result in Company A receiving a dividend as defined in subsection 6(1) of the Income Tax Assessment Act 1936 (ITAA 1936)?

Answer

No

Question 6

Will the provisions of Part IVA of the ITAA 1936 apply to the scheme, including the Proposed Amendments and the subsequent Conversion of the CPS, to cancel any tax benefit?

Answer

No

Question 7

Will an amount be included in the assessable income of Company A as a result of the issue by Company B to Company A of rights offer to acquire ordinary shares in Company B?

Answer

No

Question 8

Will Company A make a capital gain or capital loss as a result of not exercising its rights offer?

Answer

No

This ruling applies for the following periods:

1 July 20xx to 30 June 20yy

The scheme commences on:

During the year ended 1 July 20xx

Relevant facts and circumstances

The taxpayer Company A is an Australian resident company that holds ordinary shares and convertible preference shares (CPS) in another Company B that is also an Australian resident company. Company A is the largest ordinary shareholder in Company B.

Company A and B propose to amend the terms of the CPS, convert the CPS to ordinary shares, and to undertake a capital raising by way of a rights offer.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 59-40

Income Tax Assessment Act 1997 section 104-25

Income Tax Assessment Act 1997 section 104-155

Income Tax Assessment Act 1997 section 104-250

Income Tax Assessment Act 1997 section 110-25

Income Tax Assessment Act 1997 section 112-20

Income Tax Assessment Act 1997 section 116-20

Income Tax Assessment Act 1997 section 116-30

Income Tax Assessment Act 1997 section 124-810

Income Tax Assessment Act 1997 Subdivision 130-C

Income Tax Assessment Act 1997 subsection 130-60(3)

Income Tax Assessment Act 1997 section 725-245

Income Tax Assessment Act 1997 section 974-70

Income Tax Assessment Act 1997 section 974-75

Income Tax Assessment Act 1997 section 974-110

Income Tax Assessment Act 1936 subsection 6(1), definition of 'dividend'

Income Tax Assessment Act 1936 Part IVA

Reasons for decision

Question 1

Yes, the CPS will continue to be equity interests as defined in section 974-70 of the Income Tax Assessment Act 1997 (ITAA 1997) after the Proposed Amendments to the terms of the (CPS).

The Proposed Amendments would not constitute a material change under Section 974-110 of the ITAA 1997. Therefore the CPS will remain as equity interests.

Question 2

No, Company A will not make a capital gain from the happening of a CGT event as a result of the Proposed Amendments to the terms of CPS.

Division 104 sets out all the CGT events for which a taxpayer will make a capital gain or loss. For there to be such a gain or loss, the event must have occurred in respect of a CGT asset. In this instance the relevant CGT assets are the CPS.

CGT event H2 occurs in relation to the CPS however there can be no capital gain or loss as a result of CGT event H2 as Company A does not receive money or property as a result of the Proposed Amendments.

Question 3

Yes, any capital gain or capital loss that Company A might otherwise make from converting the CPS into ordinary shares in Company B will be disregarded pursuant to Subdivision 130-C of the ITAA 1997.

Under subsection 130-60(3) of the ITAA 1997 a capital gain or a capital loss made from converting a convertible interest is disregarded.

The CPS fit the definition of 'convertible interest' in subsection 995-1(1) of the ITAA 1997 and item 4 in the table at section 974-75. As the CPS are convertible interests any gain or loss made from converting them to ordinary shares of Company B will be disregarded under subsection 130-60(3) of the ITAA 1997.

Question 4

No, CGT event K8 will not happen for Company A as a result of the Proposed Amendments and rights offer.

Under section 104-250 of the ITAA 1997, CGT event K8 happens if there is a 'taxing event generating a gain' for a 'down interest' under 725-245 of the ITAA 1997.

Section 725-245 of the ITAA 1997 contains a table that sets out the various 'taxing events generating a gain' and sets out some of the CGT consequences of a direct value shift for affected owners of down interests.

It is accepted that items 1, 2 and 3 of the table at section 725-245 will not apply as Company A's interests in Company B are post-CGT assets that are neither revenue nor trading stock of Company A.

Item 4 requires there to be 'up interests owned by other affected owners.'

Section 725-85 of the ITAA 1997 sets out who is an affected owner of an up interest. An entity will be an affected owner of an up interest if there is at least one affected owner of down interests, and in this case applies to Company A. It is accepted that paragraph (b) is satisfied as Company B shareholders will be provided with rights entitlements allowing them to acquire Company B shares at a discount.

It is accepted that neither paragraphs (c), (d), (e) or (f) of section 725-85 applies. To apply paragraph 725-85(f) of the ITAA 1997 it is necessary to look at subsection 725-65(3) of the ITAA 1997 and in turn section 124-810 of the ITAA 1997.

It is accepted that section 124-810 of the ITAA 1997 will not deem Company B to have less than 300 members.

As a result, subsection 725-65(2) of the ITAA 1997 will not apply. Therefore, there are no other Company B shareholders fitting the definition of active participant in the scheme as Company B has at least 300 members. It follows that item 4 in the table in subsection 725-245 of the ITAA 1997 is not satisfied and that therefore CGT event K8 will not happen for Company A as a result of the Proposed Amendments and rights offer.

Question 5

No, the Proposed Amendments to the terms, and Conversion of the CPS will not result in Company A receiving a dividend as defined in subsection 6(1) of the Income Tax Assessment Act 1936 (ITAA 1936).

The Proposed Amendments and conversion of the CPS to ordinary shares will not result in a dividend, as defined in subsection 6(1) of the ITAA 1936, made by Company B to Company A. It will not involve a distribution of money or property by Company B to Company A. In addition the accounting by Company B for the conversion is to debit the CPS share capital account in the original issue price of $Xm and credit the ordinary share capital account in the same amount.

Question 6

No, the provisions of Part IVA of the ITAA 1936 will not apply to the scheme, including the Proposed Amendments and the subsequent conversion of the CPS, to cancel any tax benefit.

The application set out the commercial considerations for implementing the current scheme as well as potential alternatives considered which were ultimately not considered reasonable. It is accepted that the scheme was not entered into with the dominant purpose of enabling a tax benefit for Company A. Therefore Part IVA will not apply in relation to the scheme as set out in the application.

Question 7

No, an amount will not be included in the assessable income of Company B as a result of the issue by Company B to Company A of rights offer to acquire ordinary shares in Company B.

The offer will satisfy the exemption in section 59-40 of the ITAA 1997 and as a result will be considered non-assessable non-exempt income.

Question 8

No, Company A will not make a capital gain or capital loss as a result of not exercising the rights offer.

The rights are CGT assets, and given that Company A will not be exercising them, the rights will expire such that CGT event C2 happens.

As Company A does not give any money or property in acquiring the rights there is no cost base under section 110-25 of the ITAA 1997. Further there is no substituted market value cost base under paragraph 112-20(1)(a) of the ITAA 1997 as the granting of the rights by Company B (being options to acquire shares in Company B) does not constitute a CGT event happening (CGT event D2 does not happen to Company B per subsection 104-40(6) of the ITAA 1997; and CGT event C3 concerning the non-exercise of the rights is not an event under which you acquired the rights). Further paragraph 112-20(1)(c) of the ITAA 1997 is not applicable either because Company A was dealing at arm's length with Company B in connection with the acquisition of the rights, or because subsection 112-20(2) of the ITAA 1997 applies if it were not an arm's length dealing.

As Company A does not receive any money or property upon expiry of the rights upon CGT event C2 happening, there are no capital proceeds under section 116-20 of the ITAA 1997. Further pursuant to paragraph 116-30(3)(a) of the ITAA 1997 there is no substituted market value capital proceeds under s116-30 of the ITAA 1997.

Accordingly, there will be no capital gain or capital loss to Company A upon the rights expiring.

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