Edited version of your written advice

Authorisation Number: 1051370502425

Date of advice: 17 May 2018

Ruling

Subject: Division 149 of the Income Tax Assessment Act 1997

Question

Is the real property owned by X Company a pre-CGT asset?

Answer

No, due to the application of Division 149 of the ITAA 1997, the real property owned by X Company is not a pre-CGT asset. The real property ceased to be a pre-CGT asset on DD/MM/20YY.

This ruling applies for the following periods:

Year ending 30 June 20XX

Year ending 30 June 20XX

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

X Company was incorporated in Australia prior to 20 September 1985.

X Company owns multiple allotments of land (the real property) which were all acquired prior to 20 September 1985.

X Company shareholding

Ordinary shares

On incorporation, X Company had X ordinary shares on issue, held by R and D in equal number.

As at 19 September 1985, there were Y ordinary shares issued in X Company, held 51.0001% by R and 48.9999% by I Trust.

At some time during the 199X year, X Company converted (or exchanged) its issued Ordinary (ORD) shares for Ordinary1 (ORD1) shares, however there was no change to the holders of the shares or to the relative percentage of the shares held by each holder.

On DDMM20XX, R transferred some of his ORD1 shares in X Company to X Trust. The shares transferred represented 48.9999% of the issued ORD1 shares.

On DDMM20XX the I Trust vested and the ORD1 shares held in X Company at that time were transferred in equal proportions to each of M, J and C. At that time, M, J and C each became the direct owner of 16.3333% ORD1 shares in X Company.

On DDMM20YY, M settled his ORD1 shares in X Company equally onto three trusts as a result of the breakdown of his marriage, and in accordance with the terms of a binding financial agreement dated DDMMYY between M and his former wife. As a result, each of these trusts received 5.4% of the ORD1 shares in X Company.

Cumulative Preference shares

On DDMM19XX X Company issued X Cumulative Preference shares (CPSs) to R. The CPSs were redeemed by X Company in 20XX. All of the CPSs were held by R at all times between the issue date and the redemption date.

The CPSs entitled the holder to a cumulative preferential dividend of between 12% and 16% of the capital contributed on the shares. They also entitled the holder to the right on winding up to the repayment of capital and any premium paid on the shares (in priority to all other shares) and to payment of any declared, but unpaid, dividends. The CPSs did not entitle the holder any further right to participate in assets or in profits of X Company.

5% Redeemable Preference Shares

On DDMM19XX X Company issued 5% Redeemable Preference shares (5% RPSs) to P company.

On DDMM19XX, P Company transferred all 5% RPS to R.

On DDMM20XX, R transferred some of his 5% RPS to his spouse (R spouse):

1. 36% of the 5% RPS held by R spouse

2. 64% of the 5% RPS held by R.

The 5% RPSs were redeemed by X Company on DDMM 20XX.

The 5% RPSs entitled the holders to a return of paid up capital on the winding up of X Company, but not to a share in any surplus assets.

B Class Preference Shares

On DDMM20XX X Company issued B Class Redeemable Preference shares (B Prefs) to R. Those B Prefs are still on issue and have been directly held by R at all times since issue.

The B Prefs entitle their holders to receive dividends equally with the holders of ORD1 shares; the right to receive the issue price only upon redemption; and a second preferential right (behind existing preference shares) to receive the issue price only on a winding up of X Company but no right to participate further in capital.

Other matters

I Trust

I Trust was settled by R prior to 20 September 1985. The Principle Beneficiaries were:

3. the children and remoter issue of the Settlor;

4. any person who is for the time being the wife of any child of the Settlor or the unmarried widow of any such child.

The vesting date of the I Trust was 30 June 20XX or any such earlier date that the trustee nominated. I Trust vested on DDMM 20XX.

All three children (M, C and J) were alive when the I Trust vested and the capital of the trust fund was distributed equally between them, in accordance with the Trust Deed. All distributions of income by the I Trust between settlement and vesting were paid to or applied for the benefit of M, C and J, in accordance with the Trust Deed.

X Trust

X Trust was settled on DDMM20XX. The Primary Beneficiaries are R, R spouse, C, J and M. R is the Appointor of the trust fund.

Other General Beneficiaries are also specified in the Trust deed.

The X Trust deed gives the Trustee a broad power to distribute trust income or capital prior to vesting.

The X Trust deed gives the Trustee a similarly broad power to distribute trust capital upon vesting.

P Company

P Company was incorporated prior to 20 September 1985 and has X ordinary shares (which became ORD1 shares at a later date) and Y preference shares on issue.

On incorporation the Ordinary shares in P Company were held 50% by R and 50% by I Trust. Since incorporation, the shareholding in P Company changed to 51.3% R and 48.7% I Trust and then at a later date all issued shares were transferred to X Company.

On incorporation, the preference shares were held by R (50%) and I Trust (50%). Since incorporation the preference shares changed to 60.4% R and 39.5% I Trust and then at a later date it changed to 67.4% R and 32.6% I Trust and then a further change occurred whereby all issued preference shares were transferred to X Company.

Relevant legislative provision

Income Tax Assessment Act 1936 Section 160ZZS (repealed)

Income Tax Assessment Act 1936 Section 272-50 of Schedule 2F

Income Tax Assessment Act 1997 Section 108-5

Income Tax Assessment Act 1997 Subdivision 126-A

Income Tax Assessment Act 1997 Section 126-5

Income Tax Assessment Act 1997 Division 149

Income Tax Assessment Act 1997 Subdivision 149-B

Income Tax Assessment Act 1997 Section 149-15

Income Tax Assessment Act 1997 Section 149-30

Income Tax Assessment Act 1997 Section 165-245

Reasons for decision

Summary

As a result of the application of Division 149 of the ITAA 1997 the real property owned by X Company is not a pre-CGT asset. The real property ceased to be a pre-CGT asset on DDMM20YY.

Detailed reasoning

All legislative references are to the Income Tax Assessment Act 1997 unless otherwise specified.

Division 149 applies from the 1^st of July 1998 to determine whether a CGT asset of an entity stops being a pre-CGT asset. Division 149 replaced section 160ZZS in the Income Tax Assessment Act 1936, which performed the same role prior to 1 July 1998. Subdivision 149-B applies to non-public entities, like X Company.

Subsection 149-30(1) states that ‘the asset stops being a pre-CGT asset at the earliest time when majority underlying interests in the asset were not had by ultimate owners who had majority underlying interests in the asset immediately before 20 September 1985.’

The test applies continuously from 20 September 1985 until such time as the asset stops being a pre-CGT asset. When the asset stops being a pre-CGT asset due to the application of Subdivision 149-B, the first element of its cost base is deemed to be its market value at the time specified in subsection 149-30(1) (Subsection 149-35(2)).

‘Majority underlying interests’ in a CGT asset are defined in section 149-15, as:

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

2. 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.

From the definition it is clear that ultimate owners must have greater than 50% of the beneficial interests in both the asset and any ordinary income that may be derived from the asset.

‘Ultimate owners’ are defined in subsection 149-15(3) and, relevantly for the purposes of this ruling, include an individual.

Subsections 149-15(4) and (5) specify when an ultimate owner indirectly has a beneficial interest in a CGT asset of another entity or in the ordinary income that may be derived from a CGT asset of another entity, respectively.

A ‘CGT asset’ is defined in section 108-5 and includes land and buildings (Note to subsection 108-5(2)).

Who were the ultimate owners of X Company just before 20 September 1985?

Just before 20 September 1985 X Company had X ordinary shares on issue.

R legally and beneficially held 51.0001% of the ordinary shares in X Company just before 20 September 1985.

The remaining 48.9999% ordinary shares were legally held by I Trust.

The terms of the I Trust Deed created fixed entitlements to trust income and capital in favour of the three sons of R, during their lifetimes. The Deed also specifies how their respective interests will be distributed should one, or more, of them die prior to the vesting date.

In terms of the tests described in subsections 149-15(4) and (5), if X Company had distributed capital or income to I Trust just before 20 September 1985 then R’s sons would have had an equal interest in that capital or income through I Trust.

While there was the potential for other individuals to benefit under the terms of the I Trust Deed, this was contingent on one of R’s children passing away.

All three children (M, C and J) were alive when the I Trust vested and the capital of the trust fund was distributed equally between them. All distributions of income by the I Trust between settlement and vesting were paid to or applied for the benefit of M, C and J. Thus until the trust vested, M, C and J had a fixed interest in the income and capital of I Trust.

Therefore, just before 20 September 1985 the ultimate owners who had majority underlying interests in the property owned by X Company were:

The test in subsection 149-30(1) is dependent on those four individuals continuing to have majority underlying interests in the property on and after 20 September 1985.

The nature of the analysis required is demonstrated in paragraph 10 of Taxation Ruling IT 2530. It doesn’t matter how the respective underlying interests change as between the ultimate owners, as long as they collectively continue to have more than 50% of the beneficial interests in the Property and in any ordinary income that may be derived from the property. Therefore, whilst they collectively continue to have a majority underlying interest in the Property, the asset will continue to be a pre-CGT asset.

How did the underlying interests change after 19 September 1985?

Cumulative Preference shares

On DDMM19XX X Company issued Cumulative Preference shares (CPSs) to R and these were held by R until their redemption by X Company.

The CPSs entitled the holder to a cumulative preferential dividend of between 12% and 16% of the capital contributed on the shares. They also entitled the holder to the right on winding up to the repayment of capital and any premium paid on the shares (in priority to all other shares) and to payment of any declared, but unpaid, dividends. The CPSs did not entitle the holder any further right to participate in assets or in profits of X Company.

To the extent that the CPSs are taken to have conferred on the holder an indirect beneficial interest in the assets and/or the income of X Company under section 149-15, they do not impact upon the analysis required by subsection 149-30(1) as they were always 100% held by R. Any beneficial interest taken (by Division 149) to have been indirectly conferred by the CPSs in the Property or in the ordinary income derived from the Property rested with R. As R was one of the ultimate owners with majority underlying interests just before 20 September 1985, the rights conferred by the CPSs simply change the respective percentages as between the four ultimate owners identified above. The issue of the CPSs did not reduce the aggregated underlying interests of the four ultimate owners below 100%.

5% Redeemable Preference Shares

On DDMM19YY X Company issued 5% Redeemable Preference shares (5% RPSs) to P Company. These were subsequently redeemed by X Company.

There were multiple changes to the direct holder of the 5% RPSs between DDMM19YY and when they were redeemed, but at all times R had more than 50% of any underlying interests conferred by the 5% RPSs in The Property and in any income derived from the property. For completeness it is noted that the 5% RPSs entitled the holders to a return of paid up capital on the winding up of X Company, but not to share in any surplus assets.

As R held more than 50% of the 5% RPSs shares at all times they were on issue, indirectly through his holdings in P company and X Company and then directly, the analysis is the same as for the CPSs. While beneficial interests attaching to the 5% RPSs were eventually held by an ultimate owner who did not have any beneficial interests in The Property prior to 20 September 1985, being R spouse, those interests never exceeded 36.3636% of the 5% RPSs.

Conversion of Ordinary shares to Ordinary1 shares

At some time during the 199X year, X Company converted (or exchanged) its issued Ordinary (ORD) shares for Ordinary1 (ORD1) shares.

At that time there was no change to the holders of the shares or to the relative percentage of shares held by each holder. R held 51.0001% of the ORD1 shares after the change and I Trust held 48.9999% of the ORD1 shares after the change.

As there was no change to the beneficial interests that ultimate owners had as a result of the conversion or exchange, this event did not impact on the pre-CGT status of The Property.

B Class Preference Shares

On DDMM20XX X Company issued B Class Redeemable Preference shares (B Prefs) to R. These B Prefs are still on issue and have been directly held by R at all times since issue.

The B Prefs entitle their holders to receive dividends equally with the holders of ORD1 shares; the right to receive the issue price only upon redemption; and a second preferential right (behind existing preference shares) to receive the issue price only on a winding up of X Company but no right to participate further in capital.

As R has always held 100% of the B Prefs, the issue and continued holding of those shares has not reduced the percentage of underlying interests held by the four ultimate owners who had the majority underlying interests in The Property prior to 20 September 1985.

Transfer of Ordinary1 shares to the X Trust

On DDMM20XX the X Trust was settled, and R, R spouse, C, J and M are the primary beneficiaries of the trust fund.

On DDMM20XX, R transferred 48.9999% of his ORD1 shares in X Company to the trustee for X Trust.

After the transfer, R directly held 2.0002% ORD1 shares and I Trust continued to hold 48.9999% of the ORD1 shares. At DDMM20XX, regardless of the transfer of the ORD1 shares in X Company to X Trust, the four ultimate owners who held majority underlying interests in The Property prior to 20 September 1985 continued to have a minimum of 51.0001% of the beneficial interests in the Property conferred on the holders of ORD1 shares.

The Property did not stop being a pre-CGT asset on DDMM20XX because the ultimate owners who had majority underlying interests in the property just before 20 September 1985 continued to have majority underlying interests after the transfer of the ORD1 shares to X Trust.

Vesting of the I Trust

As previously mentioned, I Trust vested on DDMM20XX and the ORD1 shares the trust fund held in X Company at that time were transferred in equal proportions to each of M, J and C. At that time, M, J and C each became the direct owner of ORD1 shares in X Company (being 16.3333% each).

This transfer resulted in no change to the underlying interests in the Property. The underlying interests that M, J and C previously held indirectly through I Trust were simply vested in them directly. The four ultimate owners who held majority underlying interests in The Property prior to 20 September 1985 continued to have a minimum of 51.0001% of the underlying interests in the property conferred on the holders of ORD1 shares as at the date that the I Trust vested.

Transfer of M’s ORD1 shares onto child support trusts

On DDMM20YY, M settled his ORD1 shares in X Company equally onto three child support trusts as a result of the breakdown of his marriage.

At this point the issued shares in X Company were held by:

At this time, the percentage of ORD1 shares held by R, C, M and had fallen to 34.6668% and, without more, the result is that The Property would stop being a pre-CGT asset.

In determining whether The Property stopped being a pre-CGT asset on DDMM20YY the following questions need to be considered:

a. Do the B Prefs give the holder beneficial interests in both the asset and any ordinary income that may be derived from the asset?

b. Can we look-through X Trust on the basis described in IT 2340 and ATO ID 2003/778?

c. Does the exception in subsection 149-30(3) apply to treat the new owners as standing in the shoes of M upon the establishment of the three child support trusts?

Do the B Prefs give the holder beneficial interests in both the asset and any ordinary income that may be derived from the asset?

The B Prefs entitle their holder to receive dividends equally with the holders of ORD shares; the right to receive the issue price only upon redemption; and a second preferential right (behind existing preference shares) to receive the issue price only on a winding up of X Company but no right to participate further in capital.

By DDMM20YY all of the other preference shares had already been redeemed by X Company and the right to receive the issue price only on winding up was no longer a second preferential right.

Section 272-50 of Schedule 2F of the ITAA 1936 is informative when considering when a company makes a distribution to a shareholder. Section 272-50 states (in part):

(1) A company distributes income of the company to a person if the company pays a dividend or a non-share dividend to the person

(2) A company distributes capital of the company to a person if:

(a) it pays or credits money, or transfers property, of the company to the person, where the amount is paid or credited, or the amount or value of the property, is debited against an amount standing to the credit of the share capital account of the company; and

(b) the payment, crediting or transfer is not the payment of a dividend.

(3) .....

The X Company Constitution specifies that the B Prefs have ‘the right to receive dividends equally with the holders of ordinary shares’. On that basis, it appears uncontroversial to conclude that the B Prefs should rank equally with the ORD1 shares in terms of assessing who holds the beneficial interests in any ordinary income that may be derived from The Property for the purposes of paragraph 149-15(1)(b).

Considering the test described in subsection 149-15(5) for determining whether an ultimate owner has an indirect beneficial interest in any ordinary income that may be derived from a CGT asset of another entity, the test is whether the ultimate owner would receive for his, her or its own benefit any of a dividend the other entity were to pay.

It is unknown whether the Constitution of X Company provides a general discretion to its Directors to pay a dividend to one class of share to the exclusion of any other class. If there is a general discretion then neither the ORD1 shareholders nor the B Pref shareholders would have a fixed and continuous interest in any dividend that X Company may pay. However, this issue is unlikely to be determinative once the interests ultimate owners had in the asset itself are considered.

The B Prefs entitle their holder to receive a return of the issue price only upon redemption or upon the winding up of X Company. The B Prefs do not entitle their holder to share in any surplus capital of X Company upon winding up, beyond the return of the issue price.

The capital rights attaching to the ORD1 shares is unknown but it is assumed that those shares entitle their holders to participate in capital and to participate in any surplus capital of X Company upon winding up. If this were not the case, then no shareholders would have the right to participate in capital or to participate in surplus capital upon the winding up of X Company.

The B Prefs do not entitle the holders to participate in any distributions of capital outside of two very specific circumstances, being the redemption of the B Prefs or at the winding up of X Company (and then only to the extent of the issue price).

Considering the test described in subsection 149-15(5) for determining whether an ultimate owner has an indirect beneficial interest in a CGT asset of another entity, the test is whether the ultimate owner would receive for his, her or its own benefit any distribution of capital the other entity may pay. In this case, the relevant capital being any distribution of capital that X Company may pay.

It can’t be said that the holders of the B Prefs had entitlements to any distributions of capital that X Company may pay because their entitlement only arises in one of two very specific situations and then only for a specific amount. Outside of the redemption or winding up scenarios, the holders of the B Prefs had no entitlement to any distributions of capital that X Company may elect to pay.

While the B Prefs appear to give their holder an equal share of any dividend X Company may pay, they do not give an equal entitlement to any capital X Company may distribute, when compared to entitlements attaching to the ORD1 shares. The B Prefs can’t be considered in assessing who holds more than 50% of the beneficial interests in the asset for the purposes of paragraph 149-15(1)(a). That component of the majority underlying interest test in 149-15(1) can only be tested against the ORD1 shares due to the B Prefs not having a relevant interest in the capital of X Company.

Can we look through X TRUST on the basis described in IT 2340 and ATO ID 2003/778?

IT 2340 and ATO ID 2003/778 provides a concessional treatment for determining whether majority underlying interests are maintained where those interests are held indirectly through discretionary trusts.

Paragraph 7 of IT 2340 states that ‘trust assets acquired by the trustee before 20 September 1985 would remain outside the scope of the capital gains and losses provisions of the Act’. This statement is informative in determining how IT 2340 should apply in practice to interests held through discretionary trusts. Where the trust continues to be administered for the benefit of the same family group before and after 20 September 1985, then assets held by the trust prior to 20 September 1985 will retain their pre-CGT status.

In this instance, X Trust was only settled on DDMM20XX. It did not exist prior to 20 September 1985 and did not hold any assets prior to 20 September 1985. The ORD1 shares settled on the trust fund on DDMM20XX were previously owned beneficially by R. Upon the settlement of those shares on the trust fund, they were held for the benefit of the Primary and General Beneficiaries of X Trust as detailed in the X Trust trust deed.

The treatment in IT 2340 and ATO ID 2003/778 cannot be applied to look-through X Trust in this instance because X Trust did not own shares in X Company prior to 20 September 1985.

Further, even if it was possible to look-through X Trust in the way described in IT 2340 and ATO ID 2003/778, the trust deed of X Trust gives the trustee discretion in how capital can be paid or applied, stating that the Trustee may ‘at any time or times prior to the vesting day … add such income to the capital of the Trust Fund but so that the Trustee may at any time or times prior to the Vesting Date resort to such accumulations and pay or apply the whole or any part or parts for such charitable purpose and/or for the benefit of any or any one or more exclusive of the other or others of the General Beneficiaries living from time to time in such proportions and in such a manner as the Trustee sees fit and without being bound to assign any reason’. Clause 5 gives the Trustee a similarly broad power to distribute trust capital upon vesting.

Due to the settlement of ORD1 X Company shares onto X Trust on DDMM20XX and the wide range of potential beneficiaries of X Trust, the ultimate owners of the underlying interests attaching to those shares were not had by the same ultimate owners who held majority underlying interests just before 20 September 1985.

Does the exception in subsection 149-30(3) apply to treat the new owners as standing in the shoes of M upon the establishment of the three child support trusts?

Prior to DDMM20YY, M had an underlying interest in The Property by virtue of his fixed interest in I Trust and then by directly owning ORD1 shares in X Company.

On DDMM20YY, the ORD1 shares that M directly held in X Company were settled onto three child support trusts.

In the absence of trust deeds, it is assumed that the three children each have an indirect beneficial interest in The Property as a result of the interests they have in the ORD1 shares through their respective child support trusts. Therefore it needs to be considered as to whether the 3 children should be taken to stand in the shoes of M under subsection 149-30(3), relying on Item 1 in the table to that subsection.

Item 1 in the table to subsection 149-30(3) applies to the transfer of an asset where there is a roll-over under Subdivision 126-A (about marriage or relationship breakdowns).

Subparagraph 126-5(1)(d)(i) states that ‘there is a roll-over if a CGT asset (the trigger event) happens involving an individual (the transferor) and his or her spouse (the transferee), or a former spouse (also the transferee), because of something done under a financial agreement made under Part VIIIA of the Family Law Act 1975 that is binding because of section 90G of that Act.

M transferred his ORD1 shares in X Company to the three child support trusts in accordance with the terms of an earlier binding financial agreement between M and his former spouse. Additionally, neither the ORD1 shares nor the interest in I Trust were specifically identified in the binding financial agreement as assets of M. Rather, the ORD1 shares were dealt with under the ‘other assets’ clause in the binding financial agreement. There was a period of 3 ½ years between the date of the binding financial agreement and the transfer of the ORD1 shares from M to the respective child support trusts.

The Macquarie Dictionary defines transferor to mean ‘someone who makes a transfer, as of property’, and a transferee to mean ‘someone to whom a transfer is made, as of property’.

The ordinary reading of the words in subsection 126-5(1) makes it clear that the roll-over applies when a CGT asset is transferred from one spouse to the other (from the transferor to the transferee). On an ordinary reading, the roll-over in Subdivision 126-A would only apply if M had transferred his interest in the ORD1 shares to his former spouse.

Whether a beneficial interest vested in M’s former spouse at any time on DDMM20YY, prior to the ORD1 shares being settled on the respective child support trusts does not impact upon the conclusion in this case. The transfer of the ORD1 shares onto those three trusts does not attract the roll-over in Subdivision 126-A because those trusts cannot be the transferee described in subsection 126-5(1). This is so regardless of whether the transferor was M or his former spouse. Therefore, the exception in 149-30(3) cannot apply to allow the 3 children to stand in the shoes of M for the purpose of determining whether The Property stopped being a pre-CGT asset.

On DDMM20YY the beneficial interests in The Property that attached to the ORD1 shares previously held by M were no longer held by an entity, or entities, that had majority underlying interests just before 20 September 1985.

Conclusion

There were no changes to the underlying interests in The Property between 20 September 1985 and DDMM20YY that would trigger the application of either section 160ZZS of the ITAA 1936 or Subdivision 149-B.

At all times during that period the same ultimate owners who held majority underlying interests in The Property just before 20 September 1985 continued to hold (directly or indirectly) greater than 50% of every class of issued share in X Company. This necessarily means that they continuously held greater than 50% majority underlying interests in The Property during the same period.

The B Prefs do not give their holders the requisite beneficial interest in The Property for the purposes of paragraph 149-15(1)(a). In determining whether majority underlying interests in The Property were held by the same ultimate owners on DDMM20YY as were held just before 20 September 1985, it is the ownership of the ORD1 shares that is critical.

It is not possible to look-through the shares held by X Trust under the concessional treatment described in IT 2340 or ATO ID 2003/778 because X Trust did not exist prior to DDMM20XX. X Trust is a discretionary trust with a class of beneficiaries that is much wider than the four ultimate owners who held majority underlying interests in The Property just before 20 September 1985.

The exception that allows new owners to stand in the shoes of original owners in subsection 149-30(3) does not apply to the three child support trusts that became ORD1 shareholders in X Company on DDMM20YY because they could not be transferees under Subdivision 126-A.

As at DDMM20YY, the ultimate owners who held majority underlying interests in The Property just before 20 September 1985 held 34% of the ORD1 shares on issue at that time. As a result, The Property stopped being a pre-CGT asset on that day as a result of the application of subsection 149-30(1).

Copyright notice

© Australian Taxation Office for the Commonwealth of Australia

You are free to copy, adapt, modify, transmit and distribute material on this website as you wish (but not in any way that suggests the ATO or the Commonwealth endorses you or any of your services or products).