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Edited version of your written advice

Authorisation Number: 1012940966418

Date of advice: 11 March 2016

Ruling

Subject: Capital gains

Did CGT event A1 occur on the date the right to request shares was created pursuant to section 104-10 in relation to the disposal of shares in the Operating Company from the Holding Entity to the Receiving Entity?

Answer

No. CGT event A1 occurred in relation to the disposal of the shares on the Actual Transfer Date (ATD).

Question 2

Will subparagraph 116-30(2)(b)(i) apply to substitute the market value as the capital proceeds from the disposal of the shares?

Answer

No.

This ruling applies for the following periods:

Year ended 30 June 20XX

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

New business venture - oral agreements and understandings

Individual A wished to start up a business and took the following actions:

Individual B is the sole director for the Holding Entity and Individual A is the sole director for the Receiving Entity.

Written agreement

A Deed of Confirmation and Indemnity (the Agreement) was executed on the actual transfer date (ATD) between the Holding Entity, the Receiving Entity, Individual B and Individual A, which affirmed the earlier oral agreement (oral agreement) on the Earlier Date (ED). The ED is when the Holding Entity acquired all of the issued shares in the Operating Company. The Agreement also provided for indemnity arrangements concerning any potential tax liability with respect to the transfer of the shares in the Operating Company to the Receiving Entity.

The Agreement recites that the terms orally agreed by the ED included that the Holding Entity would acquire all of the shareholding in the Operating Company. The Holding Entity would transfer a portion of these shares (the shares) to the Receiving Entity (Individual A's nominated entity) for a set price per share at a time of Individual A's choosing.

On the ATD, Individual A chose to have the shares transferred to the Receiving Entity and a share transfer form was completed, payment was made and the register was updated to show that the Receiving Entity now held the shares formerly held by the Holding Entity. The market value of the shares at this time did not equal the purchase price.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 102-25

Income Tax Assessment Act 1997 section 104-10

Income Tax Assessment Act 1997 section 104-35

Income Tax Assessment Act 1997 section 104-40

Income Tax Assessment Act 1997 section 116-5

Income Tax Assessment Act 1997 section 116-20

Income Tax Assessment Act 1997 section 116-25

Income Tax Assessment Act 1997 section 116-30

Income Tax Assessment Act 1997 section 116-65

Income Tax Assessment Act 1997 section 995-1

Reasons for decision

Question 1

Summary

The transfer of the shares in the Operating Company from the Holding Entity to the Receiving Entity results in CGT event A1. The time of the CGT event is the ATD and not the ED.

Detailed reasoning

Section 102-25 establishes the order of application of CGT events. In particular, subsection (1) of that section provides that you work out if a CGT event (except CGT events D1 and H2) happens to your situation. If more than one event can happen, the one you use is the one that is most specific to your situation.

When the shares held by the Holding Entity were transferred to the Receiving Entity, the relevant CGT event that happened in relation to the shares was CGT event A1, which happens where there is a disposal of a CGT asset. Subsection 104-10(2) provides that a CGT asset is disposed of if there is a change of beneficial ownership. The change of beneficial ownership occurred on the ATD when the shares were transferred to the Receiving Entity.

Subsection 104-10(3) provides that the time of the CGT event is

The Commissioner does not consider that the oral agreement constituted a contract for the disposal of shares. The Commissioner further considers that there was never any intention for the contract to be a disposal contract for the shares as no actions demonstrate this intention. There was an option agreement drafted but never finalised which supports that the intent of the parties was to give Individual A the right or option to acquire the shares at a future time of his choosing for a nominal amount, rather than a contract of disposal.

The arrangements have been designed to enable Individual A to obtain the shares at a time when he/she is no longer subject to a covenant not to compete. Thus, it seems unreasonable that the contract date for disposal of the shares would be on the ED.

The actions of the relevant parties also support the conclusion that an option or right was acquired. These rights were given to Individual A in exchange for his/her prior and ongoing involvement in the business of the Operating Company. Individual A had the option to buy or not, regardless of his/her intentions to exercise the right or not at the time it was granted. Thus, Individual A was not definitively committed to the future purchase of the shares. If the business had failed before Individual A exercised his/her right, it is unlikely that he/she would then exercise his/her right. Therefore, Individual A received an option or a right to acquire shares pursuant to the oral agreement on the ED.

The oral agreement gave rise to an option (CGT event D2 pursuant to subsection 104-40(1)) or contractual right (CGT event D1 pursuant to subsection 104-35(1)), which gave Individual A the right to have the shares transferred to him/her or his/her nominee at a time of his/her choosing. However, CGT event D1 does not happen to the Holding Entity pursuant to subparagraph 104-35(5)(b) as the right requires the Holding Entity to do something that is another CGT event, namely CGT event A1 upon the disposal of shares. The capital gain or loss made from the grant of an option under CGT event D2 is disregarded pursuant to paragraph 104-40(5) as the option was exercised.

The rights were exercised and the relevant contract (share transfer form) was signed on the ATD and this is the date that of acquisition of the underlying shares.

This decision is supported by the judgement in Van v FC of T 2002 ATC 2325 (Van), which concerned an option but is equivalently applicable to rights. In that case, the taxpayer argued that the date of acquisition of the shares acquired on exercise of the option was the date the option was granted. After considering a number of authorities on the nature of an option, the Tribunal member concluded in that case:

The reasoning in relation to the acquisition date of the share for the option holder is equally applicable to the disposal date of the share for the holder or issuer of the share.

Further, consistency between the date of disposal and the date of acquisition maintains the integrity of the capital gains tax provisions.

In this case, the relevant contract for the disposal of the shares was the share transfer form, which was signed on the ATD. Prior to this date, Individual A merely held an irrevocable offer to have shares transferred to him/her or his/her nominated entity for a set price per share if he/she chose to request the transfer. Thus, the time of disposal pursuant to subparagraph 104-10(3)(a), is the ATD, being the date the contract for disposal was entered.

Question 2

Summary

As the dealings were at arm's length, subparagraph 116-30(2)(b)(i) does not apply to substitute the market value for the capital proceeds from the disposal of the shares..

Detailed reasoning

Section 116-5 provides that:

Paragraph 116-20(1) states:

Section 116-25 provides a table of modifications to the general rules. Section 116-25 relevantly provides for CGT event A1 that modifications 1, 2, 3, 4, 5 and 6 can apply and that there are special rules for disposals due to option exercise under section 116-65.

Section 116-65 applies when a disposal of a CGT asset occurs due to the exercise of an option. It provides that the capital proceeds from the disposal include any payment you received from granting the option.

In this case, the Holding Entity did not receive anything from the granting of the option or right. The grant was part of the wider arrangement agreed to by the relevant parties.

Modification 1, the market value substitution rule, contained in section 116-30 provides that you are taken to have received the market value of the CGT asset in question as valued at the time of the event:

An amount was received for the shares' disposal, a CGT A1 event, which was not equivalent to the market value of the shares. Thus where the dealing was not at arm's length, subparagraph 116-30(2)(b)(i) will apply. In this aspect the Commissioner considers that the parties were dealing at arm's length for the following reasons.

Subsection 995-1(1) provides that 'in determining whether parties deal at arm's length, consider any connection between them and any other relevant circumstances.'

The transfer of shares was made pursuant to the exercise of an option or right to purchase the shares. The arrangement was part of a wider transaction whereby Individual A and Individual B agreed to establish a new business. The arrangements were enable Individual A to obtain the shares at a time when he/she is no longer subject to a non-compete clause of his/her prior employment and to ensure the shares were not subsequently acquired at a higher value.

Paragraph 107 of the judgement by Edmonds J and Gordon J in Federal Commissioner of Taxation v. AXA Asia Pacific Holdings Ltd provides that:

Edmonds and Gordon reiterate at paragraph 113 that the transaction will be at arm's length where:

In Granby 95 ATC 4243:

In this case, both parties acted in their own interests, severally and independently in the arrangements. The terms of the Agreement were drawn up by a mutual desire of the parties to achieve their own objectives of running and owning a successful business. There is no evidence that the outcome of their dealings is anything other than a matter of real bargaining. Thus the dealings were at arm's length and subparagraph 116-30(2)(b)(i) does not apply to substitute the market value for the capital proceeds from the disposal of the shares.


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