Edited version of private advice

Authorisation Number: 1051652366385

Date of advice: 1 April 2020

Ruling

Subject: Capital gains tax

Question 1

Will the gain made by the Trust on the disposal of the shares in AusCo be assessable as a capital gain under section 6-10 of the Income Tax Assessment Act 1997 (ITAA 1997) and will not constitute income according to ordinary concepts for the purposes of section 6-5 of the ITAA 1997?

Answer

Yes

Question 2

When calculating the net capital gain from the disposal of its shares in AusCo, can the Trust treat the capital gain made as a 'discount capital gain' under Subdivision 115-A of the ITAA 1997 such that the general 50% CGT discount applies?

Answer

Yes

This ruling applies for the following period:

Year ended 30 June 20XX

The scheme commenced on:

1 July 20XX

Relevant facts and circumstances

The Trust is a discretionary trust.

AusCo was incorporated in 20XX.

AusCo's share structure comprised only ordinary shares.

The Trust acquired its shares in AusCo in July 20XX following AusCo's incorporation.

The remaining ordinary shares in AusCo were held by an unrelated third party majority shareholder.

The AusCo shares were acquired by the Trust with the intent to hold for the long term to derive dividend income.

Since AusCo's inception, it generated a steady income stream from long term arrangements to provide management services and has paid dividends to its shareholders in recent years.

The establishment of the Trust was initiated to provide an asset protection vehicle for holding long term investments for the individual and the family to benefit from.

The Trust held other investments, including shares in a company listed on the ASX and shares in other companies.

All of these shareholdings were intended to be held long term, to generate dividend income.

The Trust's ordinary shares in AusCo were sold which resulted in a capital gain for the Trust.

The Trust held more than 10% of AusCo just before the CGT event.

A majority of underlying CGT assets of AusCo by value were held for more than 12 months before the date of the CGT event, and if AusCo were to have sold its underlying CGT assets on the date of the CGT event a majority of those CGT assets would give rise to discount capital gains.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 6-5

Income Tax Assessment Act 1997 section 6-10

Income Tax Assessment Act 1997 subdivision 115-A

Income Tax Assessment Act 1997 section 115-5

Income Tax Assessment Act 1997 section 115-25

Income Tax Assessment Act 1997 section 115-45

Reasons for decision

Question 1

Summary

The gain made by the Trust on the disposal of the shares in AusCo will be assessable as a capital gain under section 6-10 of the ITAA 1997 and will not constitute income according to ordinary concepts for the purposes of section 6-5 of the ITAA 1997.

Detailed reasoning

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.

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.

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.

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.

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.

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.

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

Therefore the Trust lacks the requisite profit making intention required at the acquisition date of the shares in AusCo.

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

Accordingly, any profit or gain on the sale of AusCo shares by the Trust is not ordinary income and instead is capital in nature and subject to the capital gains tax provisions of the ITAA 1997.

Question 2

Summary

The general CGT discount will be available to the Trust when calculating the net capital gain from the disposal of its shares in AusCo, as it meets the requirements of section 115-5 of the ITAA 1997 to be a discount capital gain and does not fall within the exceptions in sections 115-40 and 115-45 of the ITAA 1997.

Detailed reasoning

To be a discount capital gain and therefore eligible for the general CGT discount, the capital gain must meet the requirements of section 115-5 of the ITAA 1997 and not fall within one of the specified exceptions.

Section 115-5 of the ITAA 1997 provides that a 'discount capital gain' is a capital gain that meets the requirements of sections 115-10, 115-15, 115-20 and 115-25 of the ITAA 1997.

In the current circumstances, the requirements of sections 115-10, 115-15 and 115-20 of the ITAA 1997 are satisfied because the capital gain was made by a trust, resulted from a CGT event happening after 21 September 1999 and the relevant cost base was calculated without reference to indexation.

Section 115-25 of the ITAA 1997 further provides that the capital gain must result from a CGT event happening to a CGT asset that was acquired by the entity making the capital gain at least 12 months before the CGT event. The Trust has held its shareholding in AusCo since its incorporation in 2015 and therefore meets this requirement.

It is noted that subsection 115-25(3) of the ITAA 1997 limits access to the 50% discount for certain CGT events, even if the asset has been held for at least 12 months, however as the relevant CGT event in this instance is CGT event A1 there is no restriction under this subsection.

Section 115-40 of the ITAA 1997 also limits access to the 50% discount for certain CGT events where the agreement giving rise to the CGT event was made within 12 months of acquiring the CGT asset. There was no such pre-existing agreement in relation to this CGT event and on that basis this section does not apply.

Section 115-45 of the ITAA 1997 also limits access to the 50% discount for certain CGT events where it involves the sale of shares in a company by a taxpayer who holds more than 10% of the company and the majority of the underlying assets of that company have been acquired less than 12 months before the CGT event.

Application of the conditions in section 115-45 of the ITAA 1997

Subsection 115-45(2) of the ITAA 1997 states that a capital gain is not a discount capital gain where the three conditions in subsections 115-45(3), (4) and (5) of the ITAA 1997 are met.

The condition in subsection 115-45(3) of the ITAA 1997 is satisfied because the Trust held at least 10% of AusCo just before the CGT event.

However, the condition in subsection 115-45(5) of the ITAA 1997 is not satisfied because more than 50% of the net capital gain, based on market value of underlying CGT assets, would be generated from underlying CGT assets held for more than 12 months.. Therefore, the amount worked out under subsection 115-45(6) of the ITAA 1997 is not more than half of the amount worked out under subsection 115-45(7) of the ITAA 1997.

Consequently, section 115-45 of the ITAA 1997 does not operate to prevent the capital gain being treated as a discount capital gain as all three conditions in subsections 115-45(3), (4) and (5) of the ITAA 1997 are not met. As subsection 115-45(5) of the ITAA 1997 is not satisfied, there is no requirement to consider the condition in subsection 115-45(4) of the ITAA 1997.

Accordingly, as the requirements of section 115-5 of the ITAA1997 are met and none of the relevant exceptions apply, the Trust is entitled to treat the capital gain made on the sale of its shares in AusCo as a discount capital gain and apply the general 50% CGT discount.

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