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Authorisation Number: 1013100794384

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Date of advice: 30 September 2016

Ruling

Subject: Capital Gains Tax Rollover

Question 1

Did former section 160ZZN(2)(e) of the Income Tax Assessment Act 1936 ('ITAA 1936') apply to treat the business name and licence held by the wholly owned company as pre-CGT assets?

Answer

Yes

Question 2

Did former section 160ZZS of the ITAA 1936 apply, upon the transfer of shares to the individual from their former spouse, to change the pre-CGT status of the business name and licence?

Answer

No

This ruling applies for the following period:

Year ended 30 June 2017

The scheme commences on:

1 July 2016

Relevant facts and circumstances

Background

In 19WW, an individual registered their business as sole proprietor.

In 19XX, the individual's former spouse was added as an additional registered owner of the individual's business. A partnership between the individual and their former spouse was then established to operate the individual's business. Each partner held a 50% interest in the partnership.

Transfer of business to a wholly owned company

In 19YY, a company was incorporated with two ordinary shares with par value $X each for the purposes of a rollover of the business assets from the partnership.

In 19ZZ, all the pre-CGT business assets of the partnership were transferred to the company. In consideration for the disposal of the pre-CGT partnership assets to the company, the partners (the individual and their former spouse) received ordinary and non-redeemable shares in the company. On the same day, the partnership was wound up.

The individual asserted that they made an election in writing pursuant to subsection 160ZZN(2)(d) of the ITAA 1936 for the CGT rollover relief to apply to the transfer of the pre-CGT partnership assets to the company. However, the individual and the wholly owned company ('company') are unable to provide a copy of the lodged section 160ZZN notice nor their income tax returns for the 19ZZ income year.

The individual also asserted that she/he and their former spouse sought legal and accounting advice to assist with the proposed restructure. The individual asserted that they recalled having discussions with their former accountants and advisers at the time of incorporation of the company, and the associated transfer of the individual's business. The discussions included the recently enacted capital gains tax ('CGT') provisions, and the need for elections to be made to preserve the pre-CGT status of their interests.

Marriage Breakdown

In 19AA, the individual and their former spouse were separated and their divorce was finalised in 19BB.

In the divorce agreement dated in 19BB and approved by a court under section 87 of the Family Law Act 1975, the individual and their former spouse agreed to vary the share capital of the company from X shares with a par value of $X to X shares with a par value of X each. Following the variation of capital, the individual and their former spouse would each hold X ordinary shares in the company with a par value of X cent per share.

It is agreed that at the time of entering into the agreements, the shares in the company had an agreed value of $X, and that the former spouse would transfer their X ordinary shares in the company to the individual for $X in the tranches outlined in your letter:

On settlement of the divorce process, the individual transferred only $X cash to their former spouse for their shares in the company, based on the company's net after tax value of $X and that no Capital Gains Tax ('CGT') was paid by their former spouse on the transfer of their shares.

Business Restructure

In early 20DD as part of a broader business restructure, the company transferred all the stores to a related company.

Immediately following the transfer, the company retained only the business name and the licence. In early 20DD, the company entered into a licence agreement with the related company, whereby the related company was to pay the company an annual charge calculated as a percentage of the total retail sales income for the year (being 0.25% in the first year), for the use of the business name.

The consideration paid by the related company in return for the stores is unknown, and documentation in respect of the transfer of the stores has not been able to be located.

Disposal of the company

The individual intends to dispose of their shares in the year ended 30 June 20EE, and requires certainty that their shares are taken to have been acquired prior to 20 September 1985, and thus, any gain on disposal of their shares in the company will be free from Capital Gains Tax.

Relevant legislative provisions

Income Tax Assessment Act 1936 Subsection 160ZZN(2)

Income Tax Assessment Act 1936 Subsection 160ZZN(2)(a)

Income Tax Assessment Act 1936 Subsection 160ZZN(2)(b)

Income Tax Assessment Act 1936 Subsection 160ZZN(2)(c)

Income Tax Assessment Act 1936 Subsection 160ZZN (2)(d)

Income Tax Assessment Act 1936 Subsection 160ZZN(6)

Income Tax Assessment Act 1936 Subsection 160ZZN(7)(a)

Income Tax Assessment Act 1936 Subsection 160A(a)

Income Tax Assessment Act 1936 Subsection 160A(d)

Income Tax Assessment Act 1936 Subsection 160M(1)

Income Tax Assessment Act 1936 Subsection 160M(1A)

Income Tax Assessment Act 1936 Subsection 160M(2)

Income Tax Assessment Act 1936 Subsection 160ZZM(1)

Income Tax Assessment Act 1936 Subsection 160ZZM(1)(b)

Income Tax Assessment Act 1936 Subsection 160ZZM(1)(c)

Income Tax Assessment Act 1936 Subsection 160ZZS(1)

Income Tax Assessment Act 1936 Subsection 160ZZS(3)

Income Tax Assessment Act 1936 section 82KZC(1)

Income Tax Assessment Act 1997 Subsection 104-10

Income Tax Assessment Act 1997 Subsection 108-5

Income Tax Assessment Act 1997 Subdivision 126-A

Income Tax Assessment Act 1997 Subsection 126-5(1)

Income Tax Assessment Act 1997 Subsection 126-5(6)

Income Tax Assessment Act 1997 Division 149

Income Tax Assessment Act 1997 Subsection 149-30(3)

Reasons for decision

These reasons for decision accompany the Notice of private ruling for the wholly owned company. While these reasons are not part of the private ruling, we provide them to help you to understand how we reached our decision. All references are to the Income Tax Assessment Act 1936 unless otherwise stated.

Issue 1 - Income Tax

Question 1

Summary

As the requirements in former section 160ZZN(2) were satisfied, the business name and licence are considered to have been acquired by the wholly owned company ('company') before 20 September 1985.

Detailed reasoning

Former section 160ZZN provided rollover relief where an asset was transferred by a non-corporate taxpayer to a wholly-owned company. To obtain the rollover relief, certain conditions need to be satisfied at the time the assets were transferred to the company. These requirements for the rollover relief are found in former subsection 160ZZN(2), as follows:

• a taxpayer (other than a company or a taxpayer in the capacity of a trustee) who was a resident of Australia disposed of an asset to a company who was also a resident of Australia: paragraph 160ZZN(2)(a);

• the consideration in respect of the disposal consisted only of non-redeemable shares in the company: paragraph 160ZZN(2)(b);

• immediately after the disposal the taxpayer was the beneficial owner of all the shares in the company: paragraph 160ZZN(2)(c);

• the taxpayer elected by notice in writing and given to the Commissioner on or before the date of lodgement of the return of the year of income in which the disposal took place: paragraph 160ZZN(2)(d).

During the period between 20 September 1985 and 28 January 1988, a partnership was only entitled by virtue of former subsection 160ZZN(6) (repealed by the Taxation Laws Amendment Act 1991) to the rollover relief provided by former subsection 160ZZN if it met the following conditions:

(a) at least one of the partners is a natural person; and

(b) immediately after the disposal the persons who were partners in the partnership beneficially owned the shares in the company in the same proportions as their respective partnership interests immediately before the disposal.

Application to your circumstances

Based on the information provided, the assets in question were the individual and their former spouse's interests in the partnership assets under former subsection 160A(d). The relevant rollover event was the disposal of the interest in the partnership assets by the partners (the individual and their former spouse) to a wholly owned company, under former subsections 160M(1) to 160M(2).

It is determined that the conditions in former subsection 160ZZN(2) were satisfied for the incorporation rollover to apply, because:

• Each of the partners (the individual and their former spouse) and the company were Australian residents at the time of the trigger event (disposal of partnership assets);

• The partners (the individual and their former spouse) received non-redeemable shares (ordinary shares) in company in consideration for the transfer of the partnership assets;

• Immediately after the disposal, the partners (the individual and their former spouse) owned all the shares in the company;

• Most importantly, both of the partners (the individual and their former spouse) who were natural persons beneficially owned the shares in the company in the same proportions as their respective partnership interests immediately before the disposal (i.e. 50% each). It satisfied former section 160ZZN(6), which provides that former section 160ZZN(2) applied to the individual and their former spouse being a partnership, since the rollover event happened between 20 September 1985 and 28 January 1988.

You asserted that the partners (the individual and their former spouse) made a valid election under subsection 160ZZN(2)(d) by written notice to the Commissioner on or before 30 June 1986. However, you are unable to locate any copy of written confirmation of the rollover election nor the income tax returns for the 19ZZ income year. The ATO records have since been destroyed.

Given the rollover election and the transaction in question occurred more than 30 years ago, it is reasonable to misplace or destroy such records. Therefore, it is determined that the requirements of the former subsection 160ZZN(2)(d) have been satisfied. Accordingly, the wholly owned company was deemed to have acquired the business name and the licence of the partnership before 20 September 1985, under the former section 160ZZN(2)(e).

Question 2

Summary

Former section 160ZZS did not apply upon the transfer of shares to the individual from their former spouse upon financial settlement of the divorce proceedings. As such, the business name and the licence retain their pre-CGT status.

Detailed reasoning

Subdivision 126-A of the ITAA 1997 (or former section 160ZZM) is the CGT provision which expressly applies upon the breakdown of marriage or similar relationships. It is an automatic rollover provision and, therefore, will operate in every case in which the conditions precedent to its operation are met - no choice by the taxpayer is necessary to trigger that operation.

Subdivision 126-A of the ITAA 1997 is applicable to assessments for the 1999 and later income years. For assessments prior to the 1999 income year, former section 160ZZM applies.

As a same asset rollover provision, subdivision 126-A of the ITAA 1997 (or former subsection 160ZZM) provides rollover relief where there is a breakdown of marriage and there is a transfer between spouses of an asset under:

• an order of a court under the Family Law Act 1975 or under a corresponding law of a foreign country; or

• a maintenance agreement approved by a court under section 87 of the Family Law Act 1975 or a corresponding agreement approved by, or otherwise sanctioned by, a court under a corresponding law of a foreign country; or

• an order of a court under a law of a State or Territory or of a foreign country relating to the breakdown of de facto marriages.

Then, under subsection 126-5(6) of the ITAA 1997 (or former subsection 160ZZM(1)(c)), any asset which was acquired by the former spouse before 20 September 1985 will retain its capital gains tax exempt status on transfer to the receiving spouse.

Change in underlying interests

For the assessments for the 1999 and later income years, subsection 126-5(6) of the ITAA 1997 explains that generally a capital gain or a capital loss made from a pre-CGT asset is disregarded under the CGT event rules in Division 104 of the ITAA 1997. Although this is subject to the operation of Division 149 of the ITAA 1997, subsection 149-30(3) of the ITAA 1997 ensures that Division 149 of the ITAA 1997 will not be triggered when pre-CGT shares are transferred to a former spouse and there is a rollover under subdivision 126-A of the ITAA 1997, as specified in item 1 in the Table.

For the assessments prior to the 1999 income years, former subsection 160ZZS might apply to deem a pre-CGT asset held by an entity to be acquired post-CGT when there was a change in majority underlying interests in the company.

Former section 160ZZS(3) specifies that the phrases "majority underlying interests" and "underlying interest" in relation to the asset are to be accorded the same meanings as those provided in relation to property subject to former Subdivision G of Division 3 of Part IIIA of the ITAA 1936.

Under section 82KZC(1), a majority underlying interest is more than one half of the beneficial interests held by a natural person, either directly or through an interposed entity, in the asset or any income that may be derived from the asset, whereas an underlying interest is "a beneficial interest held by a natural person (whether directly or through one or more interposed companies, partnerships or trusts) in the property or in any income that may be derived from the property".

Whilst, according to Taxation Ruling IT 2363, the transfer of shares in a company between spouses under former subsection 160ZZM may affect the majority underlying interests in the company and trigger the operation of former subsection 160ZZS, Determination TD 42 (withdrawn) confirms that pre-CGT shares rolled over to a spouse under former section 160ZZM will be treated as having been acquired by that spouse before 20 September 1985. Where the transferring spouse acquired the asset after 20 September 1985, the recipient spouse may adopt the cost base which would have applied to the transferring spouse if the asset had remained with that spouse.

Application to your circumstances

An incorporation rollover under former section 160ZZN occurred on 1 January 1986, which resulted in the issue of 2 new ordinary shares in the wholly owned company in return for the transfer of partnership assets to the company. As the partnership assets were acquired before 20 September 1985, the shares in the company were deemed to be acquired by the individual and their former spouse before 20 September 1985, under former section 160ZZN(7)(a), as the requirements in former sections 160ZZN(2) and 160ZZN(6) were satisfied.

As a result of the divorce, the former spouse disposed their shares in the company to the individual between a specified period, pursuant to their divorce agreement dated on a relevant date and approved by a court under section 87 of the Family Law Act 1975.

Although the marriage breakdown between the individual and their former spouse happened in 19BB, the assets (being their former spouse's shares in the company) were only transferred to the individual between a specified period. As such, both former section 160ZZM and subdivision 126-A of the ITAA 1997 should be considered in the context of a marriage breakdown.

The relevant CGT asset was the former spouse's shares in the company under section 108-5 of the ITAA 1997 and former section 160A. The relevant CGT event was the disposal of shares in the company by their former spouse under section 104-10 of the ITAA 1997 and former subsections 160M(1) to 160M(2).

As the maintenance agreements between the individual and their former spouse satisfied both former subsection 160ZZM(1)(b) and subsection 126-5(1)(b) of the ITAA 1997, the individual is deemed to have acquired the shares in the company before 20 September 1985. The former spouse's shares (that were transferred to the individual) automatically retain the pre-CGT status in the hands of the individual, upon the divorce between the individual and their former spouse.

For the transfers occurring prior to 30 June 1998, former subsection 160ZZM applied. In line with Determination TD 42 (withdrawn), the Commissioner considers that the individual held the interests in the company before 20 September 1985 for the purposes of applying former section 160ZZS. There was no change in the majority underlying interests in the assets under former sections 82KZC(1). As such, former section 160ZZS did not apply to change the pre-CGT status of the business name and the licence held by the company.

For the transfers occurring between a specified period, the individual was deemed to have acquired the shares in the company from their former spouse before 20 September 1985 under subsection 126-5(6) of the ITAA 1997. In other words, their former spouse's shares in the company were exempt from the operation of CGT and would retain its pre-CGT status in the hands of the individual (the transferee).

Pursuant to subsection 149-30(3) of the ITAA 1997, the transfer of pre-CGT shares to a former spouse (as a result of subdivision 126-A of the ITAA 1997) would not trigger Division 149 of the ITAA 1997.

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