Edited version of private advice

Authorisation Number: 1051534849765

Date of advice: 5 July 2019

Ruling:

Subject: Issue of convertible redeemable preference shares and direct value shifting

Question:

Does the issue of convertible redeemable preference shares by Company A Pty Ltd give rise to a direct value shift under Division 725 of the Income Tax Assessment Act 1997?

Answer:

No

This ruling applies for the following period:

1 July 2018 - 30 June 2019

The scheme commences on:

1 July 2018

Relevant facts and circumstances

Company B Pty Ltd (Company B) is the Trustee of B Family Trust (Trust).

The Trust owned 10 ordinary shares, being all the issued shares, in Company A Pty Ltd (Company A).

Individual C is the sole director of Company A and Company B and is the primary beneficiary of the Trust.

Individual C wishes for Company A to be controlled and owned in a particular way upon the occurrence of a particular event (Event). The goal is for the ownership of Company A after the Event to be as follows:

·           50% held by the Trust,

·           50% held by a nominated employee of Company A (Employee).

Accordingly, Individual C proposes to have Company A issue 10 convertible redeemable preference shares (CRS) at $0.10 each to Employee under the following terms:

·           The CRS can be redeemed for their paid up capital at the sole discretion of Company A at any time and without notice, and have the rights:

·  to a repayment of paid up capital on winding up or redemption,

·  to be converted to ordinary shares on a 1:1 basis on the occurrence of the Event,

·           The CRS do not have the right to receive dividends, and no right to participate in surplus assets in a winding up or capital reduction.

All the relevant parties are Australian residents for tax purpose and hold their shares on capital account.

Relevant legislative provisions

Section 725-50 Income Tax Assessment Act 1997

Section 725-55 Income Tax Assessment Act 1997

Section 725-65 Income Tax Assessment Act 1997

Section 725-80 Income Tax Assessment Act 1997

Section 725-85 Income Tax Assessment Act 1997

Section 725-145 Income Tax Assessment Act 1997

Reasons for decision

Broadly, a value shift occurs when something is done that results in the value of equity or loan interests in an entity decreasing and the value of another interests increasing, where that shift in value is reasonably attributable to something being done under a scheme, such as the issuing of new equity interests at a discount, buying back an equity interest or changing the voting rights attaching to an equity interest.

Specifically, section 725-145 of the Income Tax Assessment Act 1997 (ITAA 1997) provides that there is a direct value shift under a scheme if:

a.      there is a decrease in the market value of one or more equity or loan interests in the target entity; and

b.      the decrease in the equity or loan interests in the target entity is reasonably attributable to one or more things done under the scheme and occurs at or after the time when that thing, or the first of those things is done; and

c.      either or both of the following are satisfied:

·  one or more equity or loan interests in the target entity are issued at a discount. This issue must be, or must be reasonably attributable to the thing, or one or more of the things referred to in (b) above. The issue must occur at or after the time referred to in (b); or

·  there is an increase in the market value of one or more equity or loan interests in the target entity. The increase must be reasonably attributable to the thing, or one or more of the things referred to in (b) above. The issue must occur at or after the time referred to in (b).

Under subsection 725-150(1) of the ITAA 1997 an equity interest or loan interest is issued at a discount if the market value of the interest when issued exceeds the amount of the payment that the issuing entity receives.

In the current circumstances, it has been submitted that the market value of the CRS is equal to their issue price and paid up capital. The CRS have no right to dividends, no right to surplus assets on winding up and can be redeemed for their paid up capital at any time by Company A without any notice. The only material value held by the holder of the CRS when issued and up until the Event is the paid-up capital. The conversion right attached to the CRS is dependent on the Event happening and subject to the CRS not having been redeemed prior to this Event.

It has been further submitted that even if the CRS are held to have some material value when issued, such value would be immaterial and the de minimis exception in section 725-70 would apply to prevent the direct value shifting rules to have consequences for the down interest.

Accordingly, it is accepted that the issue of the CRS does not give rise to a direct value shift under Division 725 of the ITAA 1997.

This ruling is limited to the issue of the CRS only. This ruling does not address the potential consequences for value shifting and Part IVA of the ITAA 1936 when the CRS are converted to ordinary shares upon the occurrence of the Event.

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).