Edited version of private advice

Authorisation Number: 1051612347353

Date of advice: 27 November 2019

Ruling

Subject: Sale of shares

Question 1

Will the Taxpayer be entitled to disregard, under Subdivision 124-M of the Income Tax Assessment Act 1997 (ITAA 1997), any capital gain made on the exchange of their shares in Company A for shares in Company B pursuant to the Share Sale Deed?

Answer

Yes, to the extent the Taxpayer receives Company B shares in exchange for their shares in Company A.

Question 2

Will any profits or gains that arise for the Taxpayer as a consequence of the exchange of Company A shares constitute ordinary income according to ordinary concepts for the purposes of section 6-5 of the ITAA 1997?

Answer

No

Question 3

Will any profits or gains that arise for the Taxpayer as a consequence of the exchange of Company A shares constitute profits arising from the carrying on of a profit-making undertaking or plan under section 15-15 of the ITAA 1997?

Answer

No

This ruling applies for the following periods:

Income year ended 30 June 2020

Income year ended 30 June 2021

The scheme commenced:

During the income year ended 30 June 2020

Relevant facts and circumstances

Company A carries on a business.

Company A has both ordinary shares and preference shares on issue.

The Taxpayer and Company B both own shares in Company A.

The Taxpayer acquired their shares in Company A after 20 September 1985.

In accordance with a Share Sale Deed, the Taxpayer agreed to sell their Company A shares to Company B in exchange for shares in Company B.

Under the terms of the Share Sale Deed, if certain conditions are satisfied, the Taxpayer may also receive an additional cash payment, in respect of the sale of their Company A shares.

The Taxpayer will choose to obtain the roll-over under Subdivision 124-M of the ITAA 1997. If the Taxpayer is a 'significant stakeholder' or 'common stakeholder' in relation to the scheme within the meaning of those terms in section 124-783 of the ITAA 1997, the Taxpayer and Company B will jointly choose to obtain the roll-over.

Company B will not make a choice that the Taxpayer cannot obtain Subdivision 124-M roll-over for CGT event A1 happening in relation to the exchange of Company A shares for the purposes of subsection 124-795(4) of the ITAA 1997.

The Taxpayer is a resident of Australia as defined in subsection 6(1) of the Income Tax Assessment Act 1936 (ITAA 1936).

Relevant legislative provisions

Section 6-5 of the ITAA 1997

Section 15-15 of the ITAA 1997

Subdivision 124-M of the ITAA 1997

Reasons for decision

Question 1

Summary

1.     A Taxpayer who makes a capital gain from the disposal of their Company A shares may choose to obtain scrip for scrip roll-over, under Subdivision 124-M of the ITAA 1997, for that part of the capital gain that is attributable to the receipt of shares in Company B.

Detailed reasoning

2.     Scrip for scrip rollover, under Subdivision 124-M of the ITAA 1997, enables a shareholder to disregard a capital gain from a share that is disposed of if the shareholder receives a replacement share in exchange. It also provides special rules for calculating the cost base and reduced cost base of the replacement share.

3.     Subdivision 124-M of the ITAA 1997 contains a number of conditions for, and exceptions to, a shareholder being eligible to choose scrip for scrip roll-over. The main requirements that are relevant to the scheme that is the subject of this Ruling are:

(a) an entity exchanges shares in a company for shares in another company (paragraph 124-780(1)(a) of the ITAA 1997)

(b) the exchange is in consequence of a single arrangement that satisfies subsections 124-780(2) or (2A) of the ITAA 1997

(c) conditions for the roll-over in subsection 124-780(3) of the ITAA 1997 are satisfied

(d) further conditions, if applicable, are satisfied, and

(e) exceptions to obtaining scrip for scrip roll-over are not applicable.

(a)   an entity exchanges shares in a company for shares in another company

4.     Paragraph 124-780(1)(a) of the ITAA 1997 requires an entity (the original interest holder) to exchange a share (the entity's original interest) in a company (the original entity) for a share in another company (the replacement interest).

5.     This requirement will be satisfied as, the Taxpayer, as an interest holder in Company A, will receive shares in Company B in exchange for shares in Company A under the Share Sale Deed.

(b)   The exchange is in consequence of a single arrangement that satisfies subsection 124-780(2) or (2A) of the ITAA 1997

6.     Paragraph 124-780(1)(b) of the ITAA 1997 requires that the exchange of shares is in consequence of a single arrangement that satisfies subsection 124-780(2) of the ITAA 1997 or subsection 124-780(2A) of the ITAA 1997. For the purpose of this ruling subsection 124-780(2) of the ITAA 1997 is relevant and is addressed below.

Single arrangement

7.     'Arrangement' is defined broadly in subsection 995-1(1) of the ITAA 1997 as any arrangement, agreement, understanding, promise or undertaking whether express or implied, and whether or not enforceable (or intended to be enforceable) by legal proceedings. Paragraph 11.23 of the Explanatory Memorandum to New Business Tax System (Miscellaneous) Bill (No.2) 2000 provides that the existence of a 'single arrangement' is a question of fact determined according to whether there is more than one offer or transaction, whether aspects of an overall transaction occur contemporaneously and intention of the parties as evidenced by the objective facts.

8.     In the current circumstances, the exchange of shares between the Company A shareholders and Company B detailed in the Share Sale Deed is taken to be the 'single arrangement' for the purposes of paragraph 124-780(1)(b) of the ITAA 1997 and will satisfy the single arrangement requirement.

80% ownership

9.     Paragraph 124-780(2)(a) of the ITAA 1997 requires that shares in an entity be exchanged in a single arrangement that results in another entity or members of a wholly-owned group becoming the owner of 80% or more of the voting shares in the original entity.

10.  In the current circumstances, Company B, which is a member of a wholly owned group, will become the owner of all of the voting shares in Company A (comprising both ordinary shares and preference shares). Accordingly, the requirements of paragraph 124-780(2)(a) of the ITAA 1997 will be satisfied.

All voting share owners participate

11.  Paragraph 124-780(2)(b) of the ITAA 1997 requires that the exchange of shares is in consequence of a single arrangement in which at least all owners of voting shares in the original entity (except for the acquiring entity) could participate.

12.  This requirement will be satisfied because all of the owners of the ordinary shares and preference shares in Company A, apart from Company B which is the acquiring entity, will participate in the exchange of their shares in Company A for shares in Company B.

Participation is on substantially the same terms

13.  Paragraph 124-780(2)(c) of the ITAA 1997 requires that the exchange is in consequence of a single arrangement in which participation was available on substantially the same terms for all of the owners of interests of a particular type in the original entity.

14.  The interests in Company A are made-up of both ordinary shares and preference shares.

15.  In the current circumstances, all of the owners of the preference shares in Company A participated in the exchange on the same terms.

16.  Similarly, all of the owners of the ordinary shares in Company A (noting that there is only one shareholder, not including the acquiring entity) participated in the exchange on the same terms.

17.  An arrangement may still satisfy the requirement in paragraph 124-780(2)(c) of the ITAA 1997 if that participation is on 'substantially the same terms for all owners of interests of a particular type' if different offers are made to separate classes of shareholders.

18.  This requirement is therefore satisfied.

(c)   conditions for the roll-over in subsection 124-780(3) of the ITAA 1997 are satisfied

19.  Paragraph 124-780(1)(c) of the ITAA 1997 requires that the conditions in subsection 124-780(3) of the ITAA 1997 are satisfied. These conditions must be met in relation to each share for which scrip for scrip roll-over is chosen.

Company A shares are post-CGT shares

20.  Paragraph 124-780(3)(a) of the ITAA 1997 requires that the original interest holder acquired its original interests on or after 20 September 1985.

21.  This condition is satisfied as the Taxpayer acquired all their shares in Company A after 20 September 1985.

The Taxpayer would otherwise make a capital gain

22.  Paragraph 124-780(3)(b) of the ITAA 1997 requires that, apart from the roll-over, the original interest holder would make a capital gain from a CGT event happening in relation to its original interest.

23.  A capital gain will be made from the disposal of a Company A share by the Taxpayer if the capital proceeds for the share are more than its cost base. The applicant has advised that the market value of the Company B shares to be received by the Taxpayer will significantly exceed the cost base of their Company A shares given as part of the exchange and therefore this requirement will be satisfied.

The Taxpayer receives replacement interests in the acquiring entity

24.  Paragraph 124-780(3)(c) of the ITAA 1997 requires that the replacement interest is in the acquiring entity or the ultimate holding company of the wholly owned group which includes the acquiring entity.

25.  This requirement is satisfied as the Taxpayer will receive shares in the acquiring entity, Company B.

The Taxpayer must choose to obtain scrip for scrip roll over

26.  Paragraph 124-780(3)(d) of the ITAA 1997 requires that the original interest holder chooses the roll-over, or, if section 124-782 of the ITAA 1997 applies, the original interest holder and the replacement entity jointly choose to obtain the roll-over.

27.  This requirement is satisfied as the Taxpayer will choose to obtain roll-over or, if the Taxpayer is a 'significant stakeholder' or 'common stakeholder' in relation to the scheme within the meaning of those terms in section 124-783 of the ITAA 1997, the Taxpayer and Company B will jointly choose to obtain the roll-over.

No member of the Company B Group will issue equity (other than a replacement entity) or owes new debt under the arrangement

28.  Paragraph 124-780(3)(f) of the ITAA 1997 requires that if an acquiring entity is a member of a wholly-owned group - no member of the group issues equity (other than a replacement interest), or owes new debt, under the arrangement:

(i) to an entity that is not a member of the group; and

(ii) in relation to the issuing of the replacement interest.

29.  This requirement will be satisfied as no member of the wholly-owned group consisting of Company B and its wholly-owned subsidiaries will issue equity (other than the replacement interest) or new debt in relation to the exchange and issue of the replacement interests.

(d) Further roll-over conditions are not applicable

30.  Subsection 124-780(4) of the ITAA 1997 provides that the additional requirements in subsection 124-780(5) of the ITAA 1997 must be satisfied if the original interest holder and the acquiring entity did not deal with each other at arm's length and:

(a)       neither the original entity nor the replacement entity had at least 300 members just before the arrangement started (paragraph 124-780(4)(a) of the ITAA 1997); or

(b)       the original interest holder, the original entity and the acquiring entity were all members of the same linked group just before the arrangement started (paragraph 124-780(4)(b) of the ITAA 1997).

31.  Whether parties have dealt at arm's length is a question of fact that must be determined in any particular case. Subsection 995-1(1) of the ITAA 1997, in respect of the term 'arm's length', states that 'in determining whether parties deal at arm's length, consider any connection between them and any other relevant circumstance'.

32.  The fact that there is no ownership connection between the parties is not determinative, on its own, of whether the parties deal with each other at arm's length. The question is whether the parties dealt with each other at arm's length; The Trustee for the Estate of the late AW Furse No. 5 Will Trust v. FC of T 91 ATC 4007 at 4014-4015; (1990) 21 ATR 1123 at 1132. This will be determined by considering the terms of the dealing and any other relevant consideration (as outlined in paragraphs 33 to 38.

33.  In Granby Pty Ltd v. FC of T 95 ATC 4240 at 4243; (1995) 30 ATR 400 at 403 Lee J stated that the provision 'dealing with each other at arm's length' invited an analysis of the manner in which the parties conduct themselves in forming the transaction. The question is whether the parties behaved in the manner in which parties at arm's length would be expected to behave in conducting their affairs and the expression means, at least, that the parties have acted severally and independently in forming their bargain.

34.  Further, Lee J stated (at ATC 4244; ATR 403-404) that:

If the parties to the transaction are at arm's length it will follow, usually, that the parties will have dealt with each other at arm's length. That is, the separate minds and wills of the parties will be applied to the bargaining process whatever the outcome of the bargain may be.

35.  However, this will not be the case where the parties collude to achieve a particular result, or where one of the parties submits the exercise of its will to the discretion of the other. In such a case the lack of the exercise of an independent will in the formation of the transaction would indicate a lack of real bargaining.

36.  In Collis v. FC of T 96 ATC 4831; (1996) 33 ATR 438 the Federal Court found that the parties were not dealing at arm's length because one party was indifferent to the allocation of the sale price for the parcel of land. This indifference was indicative of a submission of one party's will to the other party's wishes which demonstrated a lack of arm's length dealing.

37.  Based on the information provided, it is considered that Company B and the Taxpayer were dealing with each other at arms' length in respect of the exchange of shares. This conclusion is based on, among other things, the nature of the relationship between Company B and the Taxpayer, the extensive negotiation process that was undertaken and that led to the execution of the Share Sale Deed and the terms of the Share Sale Deed.

38.  Accordingly subsection 124-780(5) of the ITAA 1997 will have no application to this arrangement.

(e) Exceptions to obtaining scrip for scrip roll-over are not applicable

39.  Section 124-795 of the ITAA 1997 sets out the circumstances where scrip for scrip roll-over under Subdivision 124-M of the ITAA 1997 is not available. The exceptions for scrip for scrip roll-over are outlined in the following paragraphs.

Foreign resident shareholder

40.  Subsection 124-795(1) of the ITAA 1997 provides that roll-over is not available if, just before the disposal, the original interest holder is a foreign resident unless, just after the acquisition of the replacement interest, the replacement interest is taxable Australian property.

41.  The Taxpayer is a resident of Australia and accordingly this exception is not applicable.

A capital gain cannot (apart from the roll-over) be otherwise disregarded

42.  Paragraph 124-795(2)(a) of the ITAA 1997 provides that the roll-over is not available if any capital gain the original interest holder might make from their replacement interest would be disregarded (except because of a roll-over), for example, if the shares are trading stock.

43.  This exception does not apply.

Acquiring entity is not a foreign resident

44.  Paragraph 124-795(2)(b) of the ITAA 1997 provides that the roll-over is not available if the original interest holder and the acquiring entity are members of the same wholly owned group just before the original interest holder stops owning their original interest and the acquiring entity is a foreign resident.

45.  This exception does not apply as the Taxpayer and Company B are not members of the same wholly owned group and Company B is not a foreign resident.

No roll-over is available under Divisions 122 or 615 of the ITAA 1997

46.  Subsection 124-795(3) of the ITAA 1997 provides that the roll-over is not available if a roll-over can be chosen under Division 122 or 615 of the ITAA 1997.

47.  This exception does not apply as the circumstances of the arrangement are such that a roll-over under Divisions 122 or 615 of the ITAA 1997 is not available.

Election for no roll-over

48.  Subsection 124-795(4) of the ITAA 1997 provides that roll-over is not available if the acquiring entity elects for Subdivision 124-M of the ITAA 1997 to not applyfor the original interest holders and the original interest holders must be advised of this election before the exchange of shares.

49.  Company B will not make an election for Subdivision 124-M of the ITAA 1997 to not apply for the Taxpayer.

Partial roll-over

50.  Subsection 124-790(1) of the ITAA 1997 provides that the original interest holder can only obtain a partial roll-over if its capital proceeds for its original interest include something (the ineligible proceeds) other than its replacement interest. There is no roll-over for that part (the ineligible part) of its original interest for which it received ineligible proceeds. 'Ineligible proceeds' refers to something that is made with the exchange offer other than a replacement interest in the acquiring entity. The most common form of ineligible proceeds is a cash component.

51.  In this regard, it is noted that if an amount of money is paid to the Taxpayer under the Share Sale Deed, this payment will be 'ineligible proceeds' under section 124-790 of the ITAA 1997.

Question 2

Summary

52.  Any profits or gains that arise for the Taxpayer as a consequence of the exchange of Company A shares will not constitute ordinary income according to ordinary concepts for the purposes of section 6-5 of the ITAA 1997.

Detailed reasoning

53.  Section 6-5 of the ITAA 1997 provides that the assessable income of an Australian resident includes the ordinary income derived directly or indirectly from all sources, whether in or out of Australia.

54.  Ordinary income is defined in section 6-5 of the ITAA 1997 to mean income according to ordinary concepts. The legislation does not provide any specific guidance on what is meant by income according to ordinary concepts. However, a substantial body of case law has evolved over time that identifies various factors that are taken into account in determining when an amount is income according to ordinary concepts.

55.  Ordinary income includes income that arises in the normal scope of a taxpayer's business. In addition, in limited circumstances, gains from isolated transactions, not within the ordinary scope of the taxpayer's business may form part of ordinary income.

56.  Taxation Ruling 92/3 Income tax: whether profits on isolated transactions are income (TR 92/3) provides guidance in determining whether profits from isolated transactions are income and therefore assessable under section 6-5 of the ITAA 1997.

57.  Paragraph 6 of TR 92/3 explains that profit from an isolated transaction will be ordinary income when:

·        the intention or purpose of a taxpayer in entering into the transaction was to make a profit or gain; and

·        the transaction was entered into, and the profit was made, in the course of carrying on a business or in carrying on a business operation or commercial transaction.

58.  When a transaction involves the sale of property (shares) as in the present case, for a profit or gain on the sale of the property to be categorised as ordinary income, it is usually necessary for a taxpayer to have a profit-making intention at the time the shares were acquired.

59.  In the present case, there is no indication in the facts that, when the Taxpayer acquired their shares, they did so with the view to selling the shares for a profit or gain at a later date.

60.  Rather the shares acquired in Company A were a vehicle relating to the part ownership in the underlying business.

61.  Therefore the Taxpayer lacks the requisite profit making intention required at the acquisition date of the shares in Company A.

62.  In addition, the shares acquired in Company A were not acquired by the Taxpayer in the course of carrying on a business or commercial transaction. In contrast, their investment in Company A was made for the purpose of holding the shares over the long term and potentially deriving dividend income.

63.  Accordingly, any profit or gain on the sale of Company A shares by the Taxpayer to Company B as part of the arrangement under the Share Sale Deed is not ordinary income and instead is capital in nature and subject to the capital gains tax provisions of the ITAA 1997.

Question 3

Summary

64.  Any profits or gains that arise for the Taxpayer as a consequence of the above exchange will not constitute profits arising from the carrying on of a profit-making undertaking or plan under section 15-15 of the ITAA 1997.

Detailed reasoning

65.  Section 15-15 of the ITAA 1997 provides that assessable income includes a profit arising from the carrying on or carrying out of a profit-making undertaking or plan.

66.  However, subsection 15-15(2) of the ITAA 1997 states that section 15-15 of the ITAA 1997 does not apply to a profit that arises in respect of the sale of property acquired on or after 20 September 1985.

67.  The Taxpayer acquired their shares in Company A after 20 September 1985 and therefore, section 15-15 of the ITA 1997 will not apply to any profit arising from the sale of these shares to Company B.

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