Edited version of your written advice

Authorisation Number: 1051234802484

Date of advice: 9 June 2017

Ruling

Subject: Maximum net asset value

Question 1

In working out whether it satisfies the maximum net asset value test in section 152-15 of the Income Tax Assessment Act 1997 (ITAA 1997), can the rulee work out the net value of the CGT assets of a connected entity of the rulee as at a point in time just before the CGT event, without having regard to subsections 152-20(5) and (6) of the ITAA 1997?

Answer

Yes.

This ruling applies for the following period:

1 July 2016 to 30 June 2017

The scheme commences on:

1 July 2016

Relevant facts and circumstances

Entity A is trustee of the trust.

The trust is a discretionary trust.

The trust owns shares in Entity B.

Entity B operates a business.

The shareholders of Entity B are proposing to enter into a contract for the sale of 100% of the shares in Entity B. Under the contract, the trust will be entitled to the following proceeds for its shareholding.

● a payment on completion,

● if there is no loss of a major supplier during a specific time frame following completion of the contract, a payment is payable,

● if the business loses the support of a major supplier, a payment to be made at a specified date the quantum depending on the amount by which the EBIT of the business exceeds a specific amount at a specified date,

● deferred payments if the EBIT of the business for specific years exceeds a specific income amounts, and

● a performance bonus if certain performance indicators are met during a specific period.

Entity B does not have any pre-existing earnout-type rights or obligations at the time of sale.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 152-15,

Income Tax Assessment Act 1997 section 152-20 and

Income Tax Assessment Act 1997 section 328-125.

Reasons for decision

Section 152-10 of the ITAA 1997 lists the ’basic conditions’ for accessing capital gains concessions in Division 152 of the ITAA. Relevantly, one of the conditions is satisfying the 'maximum net asset value test’.

Subsection 152-15(1) of the ITAA 1997 states:

You satisfy the maximum net asset value test if, just before the CGT event, the sum of the following amounts does not exceed $6,000,000:

(a) the net value of the CGT assets of yours;

(b) the net value of the CGT assets of any entities connected with you;

(c) the net value of the CGT assets of any affiliates of yours or entities connected with your affiliates (not counting any assets already counted under paragraph (b)).

The meaning of net value of CGT assets are explained in section 152-20 of the ITAA 1997. Subsection 152-20(1) states:

The net value of the CGT assets of an entity is the amount (whether positive, negative or nil) obtained by subtracting from the sum of the market values of those assets the sum of:

(a) the liabilities of the entity that are related to the assets, and

(b) the following provisions made by the entity:

(i) provisions for annual leave

(ii) provisions for long service leave

(iii) provisions for unearned income

(iv) provisions for tax liabilities.

In calculating the net value of CGT assets, paragraph 152-20(2)(a) of the ITAA 1997 provides that shares held by an entity in another entity that is connected with it or is an affiliate of that entity are disregarded when calculating the net value of CGT assets. Relevantly, a company is connected with another entity where that entity has the right to receive at least 40% of any distribution of income or capital (section 328-125 of the ITAA 1997).

Subsection 152-20(5) provides that, for certain transactions involving 'look-through earnout rights’, a taxpayer can choose to value assets using a different methodology. It states:

Despite subsections (1) to (4), in working out the net value of the CGT assets of an entity at the time just before the *CGT event (the valuing time), you can make a choice under subsection (6) if:

(a) at the valuing time, one or more of the entity's *CGT assets were assets for which the entity later provided, or was later provided with, one or more *financial benefits under one or more look-through earnout rights that were in existence at the valuing time; or

(b) at the valuing time, one or more of the entity's CGT assets were look-through earnout rights relating to CGT assets of:

(i) one or more of the other entities referred to in section 152-15; or

(ii) one or more entities not referred to in that section; or

(c) you are the entity, and:

(i) the CGT event referred to in section 152-15 happened because you *disposed of a CGT asset; and

(ii) your *capital proceeds from the disposal were affected by one or more financial benefits provided to, or by, you under one or more look-through earnout rights;

and no further financial benefits can be provided under any of those look-through earnout rights.

Subsection 152-20(6) of the ITAA 1997 states:

You can choose to treat the *market value of each of the *CGT assets first mentioned in the applicable paragraph of subsection (5) as if it were, at the valuing time, equal to:

(a) if paragraph (5)(a) applies - the first element of the CGT asset's *cost base at the valuing time; or

(b) if subparagraph (5)(b)(i) applies - nil; or

(c) if subparagraph (5)(b)(ii) applies - the total of the financial benefits provided under the *look-through earnout right after the valuing time; or

(d) if paragraph (5)(c) applies - those *capital proceeds.

Application to your circumstances

Entity B is an entity connected with the trust and, as such, will have the net value of its CGT assets included in the calculation. Accordingly, in working out whether it satisfies the maximum net asset value test, the trustee of the trust must:

● include the net value of the CGT assets of the trust (subsection 152-15(a));

● include the net value of the CGT assets of Entity B, its connected entity (subsection 152-15(b);

● disregard the net value of shares in Entity B (paragraph 152-20(b)).

The net values are worked out at a point in time just before the CGT event.

It is noted that subsections 152-20(5) and (6) allow have no application to the present arrangement. As noted above, the Commissioner has not formed a view on whether any part of the consideration payable to the trustee comprises or includes a 'look-through earnout right’. However, irrespective of that issue, none of the prescribed circumstances in subsection 152-20(5) of the ITAA 1997 are satisfied as under the proposed agreement. This is because:

● no earnout rights will be in existence at the valuing time, being the time just before the CGT event as required in paragraphs 152-20(5)(a) and (b) of the ITAA 1997; and

● the value of the trust’s shares in Entity B is disregarded for the purposes of calculating the net value of CGT assets as Entity B is connect with the trust. Therefore, the assets to be valued are the assets of Entity B .There are no earnouts attributable to the assets of Entity B under the non-binding agreement and therefore paragraph 152-20(5)(c) of the ITAA 1997 is not satisfied.

As the rules around look-through earnout rights do not apply in these circumstances, the net value of the CGT assets will be calculated in accordance with the existing rules without having regard to subsections 152-20(5) and (6) of the ITAA 1997.

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