Edited version of your written advice

Authorisation Number: 1051203860185

Date of advice: 20 March 2017

Ruling

Subject: Subdivision 768-G of the Income Tax Assessment Act 1997 (ITAA 1997)

Question 1

Will the disposal of the ForeignCo shares by Ausco satisfy the preconditions for a reduction to the capital gain or capital loss amount pursuant to subsection 768-505(1) of the ITAA 1997?

Answer

Yes.

Question 2

If the answer to Question 1 is Yes, will the active foreign business asset percentage of ForeignCo, as determined under the method statement in subsection 768-525(1) of the ITAA 1997, be 100%

Answer

Yes.

This ruling applies for the following periods:

Financial year ending 20XY

The scheme commences on:

The second relevant date.

Relevant facts and circumstances

Background

1. Ausco is an Australian company and is an Australian resident for income tax purposes.

2. ForeignCo is a foreign company incorporated in, and operates in, a foreign jurisdiction and is resident of that jurisdiction for tax purposes.

3. ForeignCo is not an Australian resident, nor a prescribed dual resident under subsection 6(1) of the Income Tax Assessment Act 1936 (ITAA 1936).

The initial acquisition

4. On the first relevant date, Ausco acquired ordinary shares in ForeignCo which included rights to voting, capital distributions and dividends. The shares were not listed on any stock exchange.

5. The shares were held by Ausco on capital account for Australian tax purposes.

6. The shares were not eligible finance shares or widely distributed finance shares within the meaning of Part X of the ITAA 1936.

7. The percentage of shares in ForeignCo held by Ausco varied slightly over time. However, at no point during the period of shareholding did the percentage of share capital held by Ausco decrease below 10%.

Disposal

8. On the second relevant date, Ausco entered into a contract to dispose of all of the shares it held in ForeignCo to a NewForeignCo.

9. The shareholders of ForeignCo were issued shares in NewForeignCo as consideration for their shares in ForeignCo.

10. The value of the shares issued in NewForeignCo was equal to the market value of the shares in ForeignCo at the second relevant date.

11. Ausco will prima facie make a capital gain in relation to this transaction.

12. All shares in ForeignCo had equal voting rights between the first and second relevant dates.

Financial information

13. As at 20XX, the financial statements of ForeignCo reported total assets of $A.

14. As at 20XY, the financial statements of ForeignCo reported total assets of $B.

15. There are no derivatives on the balance sheet of ForeignCo for the financial years ended 20XX or 20XY

16. None of the assets in the financial statements for the year ending 20XX or 20XY of ForeignCo are assets located in Australia or assets that have any connection with Australia.

Other relevant information

17. For the purposes of the application of Subdivision 768-G of the ITAA 1997, Ausco will elect:

● under subsection 768-515(2) of the ITAA 1997, to use the book value method, set out in section 768-525 of the ITAA 1997, for calculating the active assets of ForeignCo, and

● under subsection 768-535(2) of the ITAA 1997, to use the consolidated financial statements, as per 768-535(6) of the ITAA 1997, of ForeignCo, for calculating the active assets of ForeignCo.

18. The financial statements relied upon are the audited consolidated financial statements of ForeignCo for the year ending 20XX and 20XY. These financial statements have been prepared in accordance with the relevant accounting standards in ForeignCo's jurisdiction.

19. ForeignCo is neither a foreign life insurance company nor a foreign general insurance company.

20. During the period of shareholding there was no point at which a group of five or fewer Australian companies, or subsidiaries thereof, which satisfied any of the below criteria and held more than 50% of the share capital in ForeignCo:

● A body corporate that is an Authorised deposit taking institution for the purposes of the Banking Act 1959

● A person who carries on state banking within the meaning of paragraph 51(xiii) of the Constitution

● A registered entity under the Financial Sector (Collection of Data) Act 2001, or

● A life assurance company.

21. Further, during the period of shareholding there was never a single company, or subsidiary thereof, which satisfied any of the abovementioned criteria and held more than 40% of the share capital in ForeignCo.

22. The manner in which dividends are calculated and the condition upon which dividends are paid in respect of shares in ForeignCo would not reasonably be regarded as being equivalent to interest on a loan.

Relevant legislative provisions

Income Tax Assessment Act 1936 subsection 6(1)

Income Tax Assessment Act 1936 Part X

Income Tax Assessment Act 1997 subsection 104-10(4)

Income Tax Assessment Act 1997 subsection 108-5(1)

Income Tax Assessment Act 1997 subsection 109-5(1)

Income Tax Assessment Act 1997 Subdivision 768-G

Reasons for decision

Note: All legislative references will be to ITAA 1997 unless otherwise stated.

Question 1

Will the disposal of the ForeignCo shares by Ausco satisfy the preconditions for a reduction to the capital gain or capital loss amount pursuant to subsection 768-505(1) of the ITAA 1997?

Detailed Reasoning

Subdivision 768-G provides that Australian resident companies are required to reduce capital gains and losses that they make in relation to certain investments in foreign companies where they hold a direct voting percentage of 10% or more in the foreign company for a certain period before the relevant CGT event happens.

The gain or loss is reduced by the percentage which reflects the degree to which the assets of the foreign company are used in an active business.

Subsection 768-505(1) provides certain criteria that must be satisfied as precondition for a reduction to the capital gain or capital loss amount:

The *capital gain or *capital loss a company (the holding company) that is an Australian resident makes from a *CGT event that happened at a particular time (the time of the CGT event) to a *share in a company (the foreign disposal company) that is a foreign resident is reduced if:

(a) the holding company held a *direct voting percentage of 10% or more in the foreign disposal company throughout a 12 month period that:

(i) began no earlier than 24 months before the time of the CGT event; and

(ii) ended no later than that time; and

(b) the share is not:

(i) an eligible finance share (within the meaning of Part X of the Income Tax Assessment Act 1936); or

(ii) a widely distributed finance share (within the meaning of that Part); and

(c) the CGT event is CGT event A1, B1, C2, E1, E2, G3, J1, K4, K6, K10 or K11.

For Ausco to meet the requirements of subsection 768-505(1) in relation to Ausco's disposal of its shareholding in ForeignCo it must, therefore, be established that:

● Ausco is an Australian resident company

● ForeignCo is a foreign resident company

● The shares disposed of ForeignCo are shares in a company

● Ausco held a direct voting percentage of 10% or more in ForeignCo for a period of at least 12 months in the 24 months prior to the CGT event

● The shares held by Ausco in ForeignCo are not eligible finance shares or widely distributed finance shares within the meaning of Part X of the ITAA 1936, and

● The CGT event that gave rise to the capital gain or loss in relation to the disposal of shares by Ausco in ForeignCo is one of those listed in paragraph 768-505(1)(c).

Australian resident company

Ausco is, at all relevant times, an Australian resident and will therefore meet the requirement of subsection 768-505(1).

Foreign disposal company

ForeignCo is not an Australian or prescribed dual resident under subsection 6(1) of the ITAA 1936 and is therefore a foreign resident company. As such, it will meet the requirements of being a foreign disposal company as described in subsection 768-505(1).

Share in a company

The term 'share in a company' for the purposes of subsection 768-505(1) is defined pursuant to subsection 995-1(1) to mean a share in the capital of the company, and includes stock.

The shares in ForeignCo held by Ausco are shares in a company for the purposes of subsection 768-505(1).

Paragraph 768-505(1)(a)

The capital gain or loss incurred by Ausco may only be reduced if Ausco held a direct voting percentage of 10% or more in ForeignCo limited throughout a 12 month period that:

(i) began no earlier than 24 months before the time of the CGT event; and

(ii) ended no later than that time.

The term 'direct voting percentage' is defined for the purposes of paragraph 768-505(1)(a) pursuant to section 768-550. Subsection 768-550(1) states:

An entity's direct voting percentage at a particular time in a company is:

(a) if the entity has a voting interest (within the meaning of 334A of the Income Tax Assessment Act 1936) in the foreign company at that time amounting to a percentage of the voting power of the company - that percentage; or

(b) otherwise - zero.

Section 334A of the ITAA 1936 prescribes a 'voting interest' in a company as the following in subsection 334A(1) of the ITAA 1936:

For the purposes of this section, a company is taken to have a voting interest in another company if:

(a) the first-mentioned company is the beneficial owner of shares (other than eligible finance shares or widely distributed finance shares) in the other company that carry the right to exercise any of the voting power in the other company; and

(b) there is no arrangement in force at the relevant time by virtue of which any person is in a position, or may become in a position, to affect that right;

and the extent of the voting interest is taken to be the total number of votes that, by virtue of that right, can be cast on a poll at, or arising out of, a general meeting of the other company as regards all questions that could be submitted to such a poll.

Ausco has continually held greater than 10% of the shares and direct voting percentage, from acquisition to disposal, in ForeignCo, and will satisfy the requirements of subsection 768-505(1)(a).

Paragraph 768-505(1)(b)

The shares in ForeignCo are neither eligible finance shares nor are they widely distributed finance shares, within the meaning of Part X of the ITAA 1936.

Paragraph 768-505(1)(c)

The terms 'capital gain' and 'capital loss' are defined for the purposes of subsection 768-505(1) pursuant to subsection 995-1(1).

capital gain: for each *CGT event a capital gain is worked out in the way described in that event.

capital loss: for each *CGT event a capital loss is worked out in the way described in that event.

CGT event A1 occurred when Ausco disposed of their shareholding in ForeignCo on the second relevant date.

Under CGT event A1, subsection 104-10(4) states;

You make a capital gain if the *capital proceeds from the disposal are more than the asset's *cost base. You make a capital loss if those capital proceeds are less than the asset's *reduced cost base.

Ausco made a capital gain in respect of the disposal of shares in ForeignCo which occurred on the second relevant date.

Conclusion

The disposal of the ForeignCo shares by Ausco satisfies the preconditions for a reduction to the capital gain or capital loss amount pursuant to subsection 768-505(1).

Question 2

If the answer to Question 1 is Yes, will the active foreign business asset percentage of ForeignCo, as determined under the method statement in subsection 768-525(1) of the ITAA 1997, be 100%?

Detailed Reasoning

Section 768-510 prescribes three methods which the holding company can elect to apply to calculate the active foreign business asset percentage: the 'market value method', the 'book value method' or the default method.

Ausco, has chosen to calculate the active foreign business asset percentage of ForeignCo via the book value method under subsection 768-515(2).

Subsection 768-510(3) sets out the following in relation to the book value method:

Book value method

(3)  Work out that percentage under section 768- 525 if:

(a)  the holding company has made a choice under subsection 768-515(2) in relation to the foreign company for that time; and

(b)  there are * recognised company accounts of the foreign company for a period that ends no later than that time, but no more than 12 months before that time; and

(c)  if the foreign company was in existence before the start of the period mentioned in paragraph (b)--there are recognised company accounts of the foreign company for a period that ends at least 6 months, but no more than 18 months, before the end of the period mentioned in paragraph (b).

ForeignCo has recognised financial accounts for the periods ending 20XX and 20XY.

The methodology to be applied in using the book value method is set-out in section 768-525. Specifically, subsection 768-525(1) prescribes that the active foreign asset business percentage of the foreign holding company at the time of the CGT event is to be calculated via the following method statement:

Method statement

Step 1. Work out the foreign company's average value of total assets at that time under subsection (2).

Step 2. Work out the foreign company's average value of active foreign business assets at that time under subsection (3).

Step 3. Divide the result of step 2 by the result of step 1.

Step 4. Express the result of step 3 as a percentage, and round that percentage to the nearest whole percentage point (rounding a number ending in .5 upwards).

Step 5. The active foreign business asset percentage is:

(a) if the result of step 4 is less than 10%--zero; or

(b) if the result of step 4 is 10% or more, but less than 90%--that result; or

(c) if the result of step 4 is 90% or more--100%.

Step 1: Total assets of the ForeignCo

Subsection 768-545(1) stipulates three criteria which must be satisfied in order for an asset to be included in the total assets of a foreign company at the time of calculating the active foreign business asset percentage. These criteria are:

(a) the asset is a CGT asset at the relevant time; and

(b) the foreign company owns the asset at that time; and

(c) if the foreign company is not an AFI subsidiary whose sole or principal business is financial intermediary business - the asset is not a foreign company derivative asset.

A CGT asset, for the purposes of paragraph 768-545(1)(a), is defined pursuant to subsection 108-5(1) of the ITAA 1997 as:

(a) any kind of property; or

(b) a legal or equitable right that is not property.

Pursuant to subsection 995-1(1), a foreign resident is a person who is not a resident of Australia for the purposes of the ITAA 1936. The residency of a company is defined pursuant to paragraph 6(1)(b) of the ITAA 1936.

ForeignCo is not an Australian or prescribed dual resident under subsection 6(1) of the ITAA 1936. ForeignCo will therefore satisfy the requirement of being a foreign company for the purposes of subsection 768-545(1).

Subsection 109-5(1) sets out that a taxpayer is considered to be the owner of a CGT asset when it acquires the CGT asset. ForeignCo has acquired the CGT assets recognised on its accounting balance sheet and will be considered the owners of those CGT assets as defined pursuant to subsection 108-5(1). Further, as an election has been made to use the book value method, any assets not included in the financial statements are considered to have zero value pursuant to subsection 768-525(5).

Based on the balance sheets and notes of ForeignCo in their financial statements for the financial years ended 20XX and 20XY, the total assets are $b for the financial year ending 20XX and $c for the financial year ending 20XY.

Therefore, the result of Step 1 is $x.

Step 2: Active foreign business assets of ForeignCo

The definition of active foreign business assets is set-out in section 768-540. Specifically, subsection 768-540(1) states:

An asset is, at a particular time, an active foreign business asset of a company (the foreign company) that is a foreign resident if, at that time:

(a) the asset is an *asset included in the total assets of the company; and

(b) the asset satisfies any of these conditions:

(i) the asset is used, or held ready for use, by the company in the course of carrying on a *business;

(ii) the asset is goodwill;

(iii) the asset is a *share; and

(c) the asset is not any of the following:

(i) *taxable Australian property;

(ii) a *membership interest in a company that is an Australian resident;

(iii) a membership interest in a *resident trust for CGT purposes;

(iv) and option or a right to acquire a membership interest mention in subparagraph (ii) or (iii); and

(d) the asset is not covered in subsection (2); and

(e) if the foreign company is an AFI subsidiary (within the meaning of Part X of the Income Tax Assessment Act 1936) whose sole or principal business is financial intermediary business - the asset is not covered under subsection (4)

Subsection 768-540(2) states that:

An asset is covered by this subsection if it is:

(a) a financial instrument (other than a *share or trade debt); or

(b) either:

(i) an eligible finance share…; or

(ii) a widely distributed finance share; or

(c) an interest in a trust or partnership; or

(d) a life insurance policy; or

(e) a right or option in respect of:

(i) a financial instrument; or

(ii) an interest in a company, trust or partnership; or

(iii) a life insurance policy; or

(f) cash or cash equivalent; or

(g) an asset whose main use in the course of carrying on the business mentioned in subparagraph (1)(b)(i) is to derive interest, an annuity, rent, royalties or foreign exchange gains unless:

(i) the asset is an intangible asset and has been substantially developed, altered or improved by the foreign company so that its market value has been substantially enhanced; or

(ii) its main use for deriving rent was only temporary.

Subsection 768-540(1) is applied to all assets included in the total assets of ForeignCo.

Additionally, it is noted that:

• None of the assets considered above will be excluded as active assets by virtue of paragraph 768-540(1)(c).

• As ForeignCo is not an AFI subsidiary (within the meaning of Part X of the ITAA 1936), paragraph 768-540(1)(e) does not apply.

Consequently, the active assets are $d for the first relevant financial year and $e for the second relevant financial year.

Therefore, the result of Step 2 is $y

Steps 3-5: Active foreign business asset calculations

Based on the above, the results worked out under the method statement can be summarised as follows:

Step 1 $x

Step 2 $y

Step 3 >0.9

Step 4 90%

Step 5 100%

The active foreign business asset percentage of ForeignCo worked out under the method statement in subsection 768-525(1) is therefore 100%.

Conclusion

Consequently, the active foreign business asset percentage of ForeignCo, as determined under the method statement in subsection 768-525(1), is 100%.

Modifications

For completeness, it is relevant to note that none of the following modifications set out in subdivision 768-G applied to the present scheme:

● ForeignCo is neither an AFI subsidiary pursuant to Part X of the ITAA 1936, a foreign life insurance company nor a foreign general insurance company.

● During the period of shareholding there was no point at which a group of five or fewer Australian companies, or subsidiaries thereof, which satisfied any of the below criteria and held more than 50% of the share capital in ForeignCo:

● A body corporate that is an Authorised deposit taking institution for the purposes of the Banking Act 1959

● A person who carries on state banking within the meaning of paragraph 51(xiii) of the Constitution

● A registered entity under the Financial Sector (Collection of Data) Act 2001, or A life assurance company.

● During the period of shareholding there was never a single company, or subsidiary thereof, which satisfied any of the abovementioned criteria and held more than 40% of the share capital in ForeignCo.

The manner in which dividends are calculated and the condition upon which dividends are paid in respect of shares in ForeignCo would not reasonably be regarded as being equivalent to interest on a loan.

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