Edited version of your written advice

Authorisation Number: 1051221486881

Date of Advice: 5 May 2017

Ruling

Subject: Scrip for scrip roll-over and Subdivision 768-G

Question 1

To the extent that Subdivision 768-G of the ITAA 1997 applies, would the reduced capital gain(s) under Subdivision 768-G satisfy the exception contained in paragraph 124-795(2)(a) of the ITAA 1997 assuming all other conditions in Subdivision 124-M are satisfied?

Answer

No.

This ruling applies for the following periods:

1 July 20xx to 30 June 20xx

The scheme commences on:

This scheme has commenced.

Relevant facts and circumstances

1. You are the head entity of a tax consolidated group.

2. Company X is a subsidiary member of the tax consolidated group.

3. Both you and Company X are Australian tax residents.

4. You propose to enter into a transaction with a foreign company that is not a tax resident of Australia.

5. This transaction would be effected by the foreign company acquiring Company X from you, in exchange for shares in the foreign company (the transaction).

6. The approximate value proposition is that 100% of Company X would be equivalent in value to a minority share of the foreign company.

7. As a result of the transaction, you would own more than 10% of the foreign company.

8. After the transaction, both you and Company X would remain Australian tax residents.

9. You have entered into a series of put options with a third-party purchaser that will result in you selling your shareholding in the foreign company at one of the following points:

● Immediately after the exchange of Company X shares for shares in the foreign company

● 12 months after the share for share exchange

● 24 months after the share for share exchange or

● 36 months after the share for share exchange.

10. By exercising one of the put options, you will be able to sell the shares in the foreign company at a time depending upon which put option is exercised. You intend to exercise one of the put options.

Relevant legislative provisions

Income Tax Assessment Act 1997 (ITAA 1997) Subdivision 768-G

ITAA 1997 Subdivision 124-M

ITAA 1997 section 768-505

ITAA 1997 subsection 768-510(4)

ITAA 1997 section 768-515

ITAA 1997 paragraph 124-795(2)(a)

ITAA 1997 subsection 102-5(1)

ITAA 1997 subsection 100-30(1)

ITAA 1997 subsection 104-10(5)

ITAA 1997 subsection 118-25(1)

ITAA 1997 section 152-105

Reasons for decision

Summary

To the extent that Subdivision 768-G of the ITAA 1997 applies to a future disposals by you of shares in a foreign company, acquired by you as replacement for shares in Company X as part of a transaction with the foreign company, the reduced capital gain(s) under Subdivision 768-G would not satisfy the exception contained in paragraph 124-795(2)(a) of the ITAA 1997, as a 'reduced' gain under section 768-505 is not a 'disregarded' gain for the purposes of paragraph 124-795(2)(a).

Detailed reasoning

Legislative Background

Subdivision 124-M of the ITAA 1997 allows taxpayers to choose a scrip for scrip roll-over where post-CGT shares or trust interests owned by the taxpayer are replaced with other shares or trust interests, for example, where there is a company takeover. As a result of the scrip for scrip roll-over, a capital gain that the taxpayer makes from their original interest is disregarded.

Section 124-795(2) states:

You cannot obtain the roll-over if:

(a) any *capital gain you might make from your replacement interest would be disregarded (except because of a roll-over)

Subdivision 768-G reduces a company's capital gain or loss, arising from a CGT event that happens in relation to a share in a foreign company, by a percentage that reflects the degree to which the assets of the foreign company are used in an active business.

Section 768-505 of Subdivision 768-G states:

(1) 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. The gain or loss is reduced by the *active foreign business asset percentage (see sections 768-510, 768-530 and 768-535) of the foreign disposal company in relation to the holding company at the time of the CGT event.

(2) The gain or loss is reduced by the * active foreign business asset percentage (see sections 768-510, 768-530 and 768-535) of the foreign disposal company in relation to the holding company at the time of the CGT event.

Under section 768-505, a capital gain or loss can be reduced in part or in whole, according to the size of the active foreign business asset percentage.

Section 768-515 states:

Choice for market value method

(1) The holding company may choose to work out the * active foreign business asset percentage of the foreign company for the time of the CGT event under section 768-520.

Choice for book value method

(2) The holding company may choose to work out the * active foreign business asset percentage of the foreign company for the time of the CGT event under section 768- 525.

Method of making choice

(3) The way an entity making a choice under subsection (1) or (2) prepares its * income tax return is sufficient evidence of the making of the choice.

Note: If an entity does not make a choice under subsection (1) or (2), it will work out the active foreign business asset percentage of the foreign company in accordance with the default method in subsection 768- 510(4).

As such, if a company does not make a choice to apply the market value method or the book value method to determine the active foreign business asset percentage of the foreign company, then the default method is applied under subsection 768-510(4).

Subsection 768-510(4) states:

Default method

(4) Otherwise, that percentage is:

(a) 100% (if this section is being applied for the purposes of section 768- 505 to reduce a * capital loss of the holding company); or

(b) zero (in any other case).

Therefore, under the default method the full capital gain is taxable and any capital loss is reduced to nil. Under the market value or book value methods, a capital gain may be reduced to zero, or reduced by a percentage.

Analysis

In order to determine whether the exception to scrip for scrip roll-over in paragraph 124-795(2)(a) is satisfied, it must be determined whether 'reduced' in section 768-505 is synonymous with 'disregarded' in paragraph 124-795(2)(a). This would mean that a capital gain, that 'might' be made in relation to the replacement shares, that is reduced under Subdivision 768-G - particularly if reduced to zero - is considered one that be 'disregarded' for the purpose of subsection 124-795(2).

You have acquired a number of put options which give you the right to sell the replacement shares that you will acquire in the foreign company. By exercising one of the put options, as you intend to do, a future capital gain would be crystallised in relation to the replacement shares, satisfying a requirement that a future capital gain 'might' be made in relation to the replacement shares. If Subdivision 768-G applies to reduce a capital gain made on the exercise of one of the four options, then it must be determined whether this reduction is considered a 'disregarded' capital gain under subsection 124-795(2).

Neither 'disregard' nor 'reduce' are defined terms in the legislation. The Macquarie Dictionary defines 'disregard' as:

1. to pay no attention to; leave out of consideration.

2. to treat without due regard, respect, or attentiveness.

'Reduce' is defined in the Macquarie Dictionary as:

1. to bring down to a smaller extent, size, amount, number, etc.

2. to lower in degree, intensity, etc.: to reduce speed.

Even if the practical effect of reducing or disregarding something might be very similar, the dictionary definitions are quite different for the two terms.

Taxation Determination TD 2006/9 Income tax: capital gains tax: scrip for scrip roll-over: is the reference to a roll-over in paragraph 124-795(2)(a) of the Income Tax Assessment Act 1997 limited to a replacement asset roll-over listed in section 112-115 of the Income Tax Assessment Act 1997 or to a same asset roll-over listed in section 112-150 of the Income Tax Assessment Act 1997? (TD 2006/9) considers what constitutes a 'roll-over' for the purpose of paragraph 124-795(2)(a) in determining whether scrip for scrip roll-over will be denied by that provision. Throughout TD 2006/9, the word 'disregarded' is specifically used, and examples of provisions that, when operating in relation to capital gains made from replacement interests, similarly specifically use the word 'disregarded'. For example, paragraph 11 of TD 2006/9 references subsection 130-60(3) of the ITAA 1997. This subsection states:

A *capital gain or *capital loss you make from converting the convertible interest is disregarded. [Emphasis added]

Various CGT provisions provide further guidance on the interpretation of the relevant terms. For example, the distinction and contrast between 'disregard' and 'reduce' is made explicitly in subsection 100-30(1), which states:

Once you identify a CGT event which applies to you, you need to know if there is an exception or exemption that would reduce the capital gain or loss or allow you to disregard it. [Emphasis added]

Another example is the method statement at subsection 102-5(1), which sets out how capital gains may be 'reduced' in working out a net capital gain, in contrast to disregarded gains:

(1) Your assessable income includes your net capital gain (if any) for the income year. You work out your net capital gain in this way:

Working out your net capital gain

Step 1. Reduce the *capital gains you made during the income year by the *capital losses (if any) you made during the income year.

Note 1: You choose the order in which you reduce your capital gains. You have a net capital loss for the income year if your capital losses exceed your capital gains: see section 102-10.

Note 2: Some provisions of this Act (such as Divisions 104 and 118) permit or require you to disregard certain capital gains or losses when working out your net capital gain. Subdivision 152-B permits you, in some circumstances, to disregard a capital gain on an asset you held for at least 15 years.

Step 2. Apply any previously unapplied *net capital losses from earlier income years to reduce the amounts (if any) remaining after the reduction of *capital gains under step 1 (including any capital gains not reduced under that step because the *capital losses were less than the total of your capital gains).

Note 1: Section 102-15 explains how to apply net capital losses.

Note 2: You choose the order in which you reduce the amounts.

Step 3. Reduce by the *discount percentage each amount of a *discount capital gain remaining after step 2 (if any).

Note: Only some entities can have discount capital gains, and only if they have capital gains from CGT assets acquired at least a year before making the gains. See Division 115.

Step 4. If any of your *capital gains (whether or not they are *discount capital gains) qualify for any of the small business concessions in Subdivisions 152-C, 152-D and 152-E, apply those concessions to each capital gain as provided for in those Subdivisions.

Note 1: The basic conditions for getting these concessions are in Subdivision 152-A.

Note 2: Subdivision 152-C does not apply to CGT events J2, J5 and J6. In addition, Subdivision 152-E does not apply to CGT events J5 and J6.

Step 5. Add up the amounts of *capital gains (if any) remaining after step 4. The sum is your net capital gain for the income year.

Note: For exceptions and modifications to these rules: see section 102-30.

This method statement shows that there are many contexts in which a capital gain is 'reduced', outside of Subdivision 768-G. These are not 'reductions' that would cause the capital gain to be 'disregarded' as per paragraph 124-795(2)(a). There is no indication that a different interpretation of the word 'reduce' in Subdivision 768-G should be applied.

In the relevant provisions of each of the divisions referenced in Note 2 to Step 1 of the method statement, the word 'disregarded' is explicitly used - for example, see subsections 104-10(5), 118-25(1) and 152-105 - and there is no indication that the words 'disregarded' and 'reduced' are interchangeable.

Thus, while the word 'disregarded' is not a technical or defined term, it is used in a precise way in the CGT provisions in the Tax Acts. A provision that would satisfy paragraph 124-795(2)(a), but for it being a roll-over, is one where the word 'disregard' is explicitly used. When a capital gain in explicitly disregarded (other than as a result of a roll-over) in such a way for the purpose of subsection 102-5(1), the exception to scrip for scrip roll-over in paragraph 124-795(2)(a) is then satisfied.

In this context, the 'reduction' of a capital gain or loss under subsection 768-505 is not synonymous with the 'disregarding' of a capital gain referred to in paragraph 124-795(2)(a), as the term 'disregarded' is used quite precisely and consistently within the legislation.

Subdiv 768-G does not use the word 'disregarded', only 'reduced'. However, the Explanatory Memorandum for the New International Tax Arrangements (Participation Exemption and Other Measures) Bill 2004 (EM), which introduced Subdivision 768-G, does state that capital losses are 'disregarded' when the active foreign business asset percentage is 90% or more, either as calculated under the book value or market value methods, or as deemed by the default method. At other times, the word 'reduced' is used in relation to capital losses that are reduced to zero or a lesser extent.

In contrast, in relation to capital gains, the EM only states that 'none of a gain is disregarded' under the default method where a capital gain has arisen, or that a capital gain is 'reduced', to a lesser extent or 'to zero', even when in the same example it is stated that a loss is 'disregarded'. The EM does not state that capital gains are ever 'disregarded' under Subdivision 768-G, only 'reduced'. As such, the suggestion in the EM that capital losses are disregarded by section 768-505 does not suggest that the exception to scrip for scrip roll-over in paragraph 124-795(2)(a) is satisfied.

As 'reduced' is not synonymous with and does not mean 'disregarded', paragraph 124-795(2)(a) would not be satisfied as a result of section 768-505, with a reduction of a future capital gain upon sale of replacement interests under Subdivision 768-G not preventing a taxpayer from obtaining scrip for scrip roll-over for those replacement interests under Subdivision 124-M.

Conclusion

To the extent that Subdivision 768-G of the ITAA 1997 applies to a future disposal by you of shares in the foreign company, acquired by you as replacement for shares in Company X as part of a transaction with the foreign company, the reduced capital gain(s) under Subdivision 768-G would not satisfy the exception contained in paragraph 124-795(2)(a) of the ITAA 1997, as a 'reduced' gain under section 768-505 is not a 'disregarded' gain for the purposes of paragraph 124-795(2)(a).

Therefore, you would not be denied scrip for scrip roll-over under Subdivision 124-M as a result of the disregarding of a future potential capital gain that you might make from the replacement shares acquired from the foreign company.

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