Edited version of your written advice

Authorisation Number: 1051228325810

Date of advice: 20 July 2017

Ruling

Subject: CGT - Majority underlying ownership

Question 1

For the purpose of section 149-30 of the Income Tax Assessment Act 1997 (ITAA 1997), would the Commissioner be satisfied, or think it reasonable to assume, that at all times on and after 20 September 1985 and before the end of each of the income years to which this ruling applies, the majority underlying interests in the pre –CGT assets of Company A were held by ultimate owners who had majority underlying interests in the pre –CGT assets immediately before 20 September 1985?

Answer

Yes

This ruling applies for the following periods:

1 July 20XX to 30 June 20YY

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

Company A was incorporated pre 20 September 1985, as a family business. Company A has disposed of part of its operation. The business sold is one identified with CGT assets existing before 20 September 1985. The completion date for the sale was in the income year ended 2017.

1. Shareholding

i. Shareholding prior to 20 September 1985

Prior to 20 September 1985, Company A was owned legally and beneficially by two family companies: C Holdings Pty Ltd (CH) (90%) and D Holdings Pty Ltd (DH) (10%). At this time Company A had only ordinary shares on issue. CH and DH each had ordinary shares and preference shares on issue.

The preference shares in each of CH and DH carried rights to a 7% cumulative preference dividend; such dividend was also preferential on winding-up to the extent that preference dividends remained unpaid at that time.

Immediately prior to 20 September 1985, 100% of the ownership of CH and DH and of Company A was held by Parent 1 and Parent 2 as Trustees of their Children’s Trust (Children’s Trust) which was settled in 19XX. The discretionary objects of the Children’s Trust were the children of Parent 1 and Parent 2 and their grandchildren.

Since this time there have been eight changes in the shareholding of Company A, CH and DH.

ii. 1 June 19AA

On 1 June 19AA, the issued shares in Company A were split in order to double the quantity of shares on issue. Shares were issued proportionately to existing shareholders.

iii. 1 June 19BB

On 1 June 19BB, two new classes of shares, A and B Class shares, were issued in Company A. One share of each class was issued; the A Class share to Parent 1 and the B Class share to Parent 2. The shares were issued to Parent 1 and Parent 2 in their own right rather than as Trustees for the Children’s Trust.

The rights attaching to the new classes of shares differed. The holder of the A Class share was entitled to vote at meetings of Company A or upon any poll on the basis of shares held, and the holder was also entitled to dividends on a discretionary basis. On winding-up, the holder of A Class shares was entitled only to a return of paid-up capital. The holder of the B Class share was entitled to receive notice of meetings, but no right to vote at meetings on a poll, and to dividends on a discretionary basis. On winding-up, the holder of B Class shares was entitled to participate on a pro-rata basis.

iv. 1 June 19CC

On 1 June 19CC, a new class of share, an A Class share, was issued in each of CH and DH. No change occurred in the shareholding of Company A. An A Class share was issued to each of Parent 1 and Parent 2; the share in CH to Parent 1 and the share in DH to Parent 2. The shares were issued to Parent 1 and Parent 2 in their own right rather than as Trustees for the Children’s Trust. The rights attaching to the new A Class shares were identical.

The holder of an A Class share was entitled to receive notice of meetings, but no right to vote at meetings at which a vote of members was taken upon a poll, and dividends on a discretionary basis. On winding-up, the holder of A Class shares was entitled to a return of paid-up capital.

Around 19II, there was a planned transition of primary involvement in the businesses from Parent 1 and Parent 2 to one of their children (the Child).

v. 1 June 19DD

On 1 June 19DD, the Ordinary shares held by DH in Company A were transferred to CH; the result being CH became the sole owner of the issued Ordinary shares in Company A. Further, an A Class share in CH (the second A Class share issued by CH) was issued to Parent 1. The rights attaching to the A Class shares in CH are as detailed above.

vi. 1 May 19EE

Pursuant to the planned transition, on 1 May 19EE, all of the Ordinary shares held by CH in Company A together with the single A and B Class shares held by Parent 1 and Parent 2 in Company A were transferred to a new trust, the Child’s Family Trust (CFT). The Trustee of CFT was controlled by the Child and the Child was the Appointor for CFT.

The discretionary objects of CFT included the Child, their spouse, their children and grandchildren, their siblings, nieces and nephews and companies in which the discretionary objects were shareholders. On the same date, a single G Class or Governing share in Company A was issued to Parent 1.

The G Class share broadly carried a voting right which generally outclassed (collectively) all other classes of shares but was both limited in specific circumstances and protected in certain other circumstances, it carried an equal right to an Ordinary share to a return of capital on a winding-up, no right to share in surplus assets and no right to dividends.

vii. 1 March 19FF

On 1 March 19FF, a further A Class share in Company A was issued to CH.

viii. 1 June 19GG

On 1 June 19GG, the single G Class share held by Parent 2 in Company A was transferred to CFT.

ix. 1 May 20HH

On 1 May 20HH the A Class share held by CH in Company A was also transferred to CFT.

The position from 1 May 20HH was that all issued shares in Company A were owned by CFT.

1. Income distributions and dividend flows

Parent 1 and Parent 2 were not discretionary objects in the Children’s Trust, nor were they discretionary objects of the CFT. As such, they could not benefit under either of the trusts.

The accounting/trust law income of the Children’s Trust was distributed amongst the children of Parent 1 and Parent 2 during each of the income years ended 30 June 1985, 1986, 1987, and 1988.

CFT has, in the main, distributed accounting/ trust law income and net income to Company B Pty Ltd (a company wholly owned by the Child from 1 May 20HH) in almost all of the income years ended 30 June 19EE to 30 June 20XX. Other income distributions have been made to the Child, their spouse, their children and their nephews. Currently the sole shareholder and sole Director of the Trustee company is the Child.

For the income years ended 30 June 19CC and 19II, all dividend income was paid to the holders of A and B Class shares in Company A - being Parent 1 and Parent 2 respectively. Dividends were also paid to the holders of A Class shares in CH and DH for the same time – being Parent 1 and Parent 2 respectively.

The holders of preference shares in CH and DH were paid dividends in the income years ended 19YY to 19II, which did not exceed more than 17% of the total amount of dividends paid in such years.

Relevant legislative provisions

Income Tax Assessment Act 1936 Section 160ZZS

Income Tax Assessment Act 1997 Section 149-15(1)

Income Tax Assessment Act 1997 Section 149-15(2)

Income Tax Assessment Act 1997 Section 149-15(3)

Income Tax Assessment Act 1997 Section 149-15(4)

Income Tax Assessment Act 1997 Section 149-15(5)

Income Tax Assessment Act 1997 Section 149-30(1)

Income Tax Assessment Act 1997 Section 149-30(2)

Reasons for decision

The Commissioner thinks it is reasonable to assume that the majority underlying interests in the pre –CGT assets of Company A were at all times held by ultimate owners who had majority underlying interests in the pre –CGT assets immediately before 20 September 1985.

Division 149 of the ITAA 1997

Division 149 of the ITAA 1997 determines when an asset acquired on or before 19 September 1985 stops being a pre CGT asset.

In accordance with subsection 149-30(1) of the ITAA 1997, an asset will stop being a pre-CGT asset at the earliest time when majority underlying interests in the asset are not had by the same ultimate owners who had majority underlying interests before 20 September 1985.

Alternatively, if the Commissioner is satisfied or thinks it reasonable to assume that, at all times on and after 20 September 1985 and before a particular day, majority underlying interests in the asset were had by ultimate owners who had majority underlying interests in the asset immediately before that day, subsections 149-30(2) of the ITAA 1997 would apply as if that were in fact the case, so that the assets would retain their pre-CGT asset status.

Section 149-15 of the ITAA 1997

Section 149-15 provides:

(1) Majority underlying interests in a *CGT asset consist of:

(a) more than 50% of the beneficial interests that *ultimate owners have (whether directly or *indirectly) in the asset; and

(b) more than 50% of the beneficial interests that *ultimate owners have (whether directly or *indirectly) in any *ordinary income that may be *derived from the asset.

(2) An underlying interest in a *CGT asset is a beneficial interest that an ultimate owner has (whether directly or *indirectly) in the asset or in any *ordinary income that may be *derived from the asset.

(3) An ultimate owner is:

(a) an individual; or

(b) a company whose *constitution prevents it from making any distribution, whether in money, property or otherwise, to its members; or

(c) ...;

(4) An *ultimate owner indirectly has a beneficial interest in a *CGT asset of another entity (that is not an *ultimate owner) if he, she or it would receive for his, her or its own benefit any of the capital of the other entity if:

(a) the other entity were to distribute any of its capital; and

(b) the capital were then successively distributed by each entity interposed between the other entity and the ultimate owner.

(5) An *ultimate owner indirectly has a beneficial interest in *ordinary income that may be *derived from a *CGT asset of another entity (that is not an *ultimate owner) if he, she or it would receive for his, her or its own benefit any of a *dividend or income if:

(a) the other entity were to pay that dividend, or otherwise distribute that income; and

(b) the dividend or income were then successively paid or distributed by each entity interposed between the other entity and the ultimate owner.

Majority underlying interests and underlying interests

The 'majority underlying interests' test requires the identification of the ultimate owners who held either directly or indirectly more than 50% of the beneficial interests, in the asset (capital entitlement) and the ordinary income derived from the asset just prior to 20 September 1985.

An underlying interest is traced back to natural persons (individuals) and other relevant entities who are ultimate owners.

It is possible for the ultimate owners to alter the way in which they hold their pre-20 September 1985 interest in an asset (or in the income derived from it) without affecting the pre-CGT status of that asset.

The expression 'beneficial interests' as used in the definition of 'majority underlying interests' is not defined. At general law, a shareholder does not have any legal or equitable interest in the asset of a company. Similarly, beneficiaries in a discretionary trust do not have an interest, either individually or collectively, in the assets or the income of a trust. This situation is addressed in ATO Interpretive Decision 2003/778:

'Under ordinary legal concepts, where there is a discretionary trust deed, no beneficiary is entitled to income or capital of the trust until the trustee exercises its discretion to distribute income or to make an appointment of capital. Because the beneficiary of a discretionary trust does not hold an interest in any asset of the trust or in the ordinary income derived from the asset until the trustee's discretion is exercised, it would not be possible for a discretionary trust to satisfy the continuing majority underlying interests test set out in subsection 149-30(1) of the ITAA 1997.

Taxation Ruling IT 2340 reflects on an approach of looking through interposed entities to determine which natural persons hold the beneficial interests for the purposes of section 160ZZS of the Income Tax Assessment Act 1936 (ITAA 1936), which preceded Division 149 of the ITAA 1997….. Among other issues, IT 2340 deals with questions regarding the application of section 160ZZS of the ITAA 1936 'to assets held by trustees of family trusts where the trustees are vested with discretionary powers as to distributions from the trusts.'

Taxation Ruling IT 2340 states at paragraph 5 that it will be relevant to take into account the way in which:

5. The discretionary powers of the trustee are exercised in considering the question of whether majority underlying interests have been maintained in the assets of the trust.

IT 2340 continues:

6. Where a trustee continues to administer a trust for the benefit of members of a particular family, for example, it will not bring section 160ZZS into application merely because distributions to members who are beneficiaries are made in such amounts and to such of those beneficiaries as the trustee determines in the exercise of his discretion.

7. In such a case the Commissioner would, in terms of subsection 160ZZS(1), find it reasonable to assume that for all practical purposes the majority underlying interests in the trust assets have not changed…

As detailed in the facts, there have been a number of specific changes to the shareholding of Company A, CH and DH, where shares with differing rights to ordinary shares were issued. The creation of the different share classes did not change the majority underlying interests, as the majority of the rights to the income and capital of the assets of Company A, remained with the underlying owners of the ordinary shares in Company A.

On 1 May 1992, CFT became the holder of all ordinary, A Class, and B Class shares in Company A (100%). The question which arises here is whether transferring such shares in Company A to the CFT caused the assets of Company A to lose their pre-CGT status, on the basis that there has been a change of more than 50% in the majority underlying assets of Company A.

In order to answer this question (and relying on the guidance contained in paragraph 2 of IT 2340), it is necessary to determine whether there has been a change in the underlying interests of the assets of Company A. In other words, whether the beneficial interests held by natural persons, whether directly or through one or more interposed companies or trusts has changed.

It is considered that there has been no change in the majority underlying interests in the assets of Company A, as the ultimate beneficial owners have remained the same. The ultimate owners have continued to be the same family group both pre and post September 1985. There have been no new ultimate owners.

Paragraph 8 of IT 2340 provides that where for example, new members of a new family are substituted as recipients of distributions from the trust in place of persons who were formerly the objects of such distributions, there is in practical effect a change of 50% or more in the underlying interests in the trust assets. Paragraph 5 of IT 2340 also provides that it is necessary to take into account the way in which the discretionary powers of the trustee were exercised in order to determine the question of whether underlying interests have been maintained.

Information provided to the ATO, demonstrates that the respective trustee(s) of the Children’s Trust and the CFT have administered each trust for the benefit of members of the family group, both pre and post 20 September 1985. It is noted that the family group meets the definition of a particular family as provided in paragraph 6 of IT 2340, and the trustee has not exercised discretionary powers to appoint beneficiaries not of the same family as the existing beneficiaries.

Additionally, the information provided to the ATO, contains a summary of dividend flows and income distributions made for most of the income years ended 30 June 1985 to 30 June 2016. This summary, demonstrates that more than 50% of the beneficial interests that ultimate owners have in income derived from the assets of Company A have continued to flow to members of a particular family – being the family group.

In accordance with paragraph 7 of IT 2340, the Commissioner would, in terms of subsection 160ZZS(1) of the ITAA 1936 (which preceded subsection 149-30(1) of the ITAA 1997), find it reasonable to assume that for all practical purposes the majority underlying interests in the trust assets have not changed.

Conclusion

On the basis that the ultimate beneficial owners of the underlying assets of Company A have been held by the same family (the family group), the Commissioner considers it reasonable to assume for the purposes of subsection 149-30(2) of the ITAA 1997, the majority underlying interests in the assets of Company A have been held at all times by the same ultimate owners who held such interests before 20 September 1985.

As such, the assets of Company A would retain their pre-CGT status for the purposes of Division 149 of the ITAA 1997.

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