Edited version of private advice

Authorisation Number: 1051657498471

Date of advice: 17 April 2020

Ruling

Subject: Capital gain exemption - section 23AH

Question 1

In the event that Taxpayer A makes a capital gain from the disposal of its net business assets (other than the shares in a related party), will this gain be disregarded for the purposes of Part 3-1 of the ITAA 1997 on the basis that it satisfies the requirements of subsection 23AH(3) of the ITAA1936?

Answer

Yes

Question 2

In the event that Taxpayer B makes a capital gain from the disposal of its net business assets (other than the shares in a related party), will this gain be disregarded for the purposes of Part 3-1 of the ITAA 1997 on the basis that it satisfies the requirements of subsection 23AH(3) of the ITAA 1936?

Answer

Yes

This ruling applies for the following period:

Income year ending 31 December 20XX

Income year ending 31 December 20XX

The scheme commences on:

1 January 20XX

Relevant facts and circumstances

Taxpayer A

Taxpayer A is part of a large group that conducts businesses over several jurisdictions.

Taxpayer A is a private company that was incorporated in Country X, however Taxpayer A is a resident of Australia for tax purposes on the basis that it satisfies the statutory test for residency in subsection 6(1) of the ITAA 1936.

Taxpayer A carries its business activities from premises located in foreign countries.

Taxpayer A is planning on disposing its core business assets and liabilities to a foreign wholly owned subsidiary within the same group.

Taxpayer A also holds assets and liabilities that are unrelated to its core business activities which will not be disposed of as part of this transaction.

Taxpayer B

Taxpayer B is part of a large group (which includes Taxpayer A) that conducts businesses over several jurisdictions.

Taxpayer B is a private company that was incorporated in Country Y however Taxpayer B is a resident of Australia for tax purposes on the basis that it satisfies the statutory test for residency in subsection 6(1) of the ITAA 1936.

Taxpayer B carries its business activities from premises located in foreign countries.

Taxpayer B is planning on disposing its core business assets and liabilities to a foreign wholly owned subsidiary within the same group.

Taxpayer B also holds assets and liabilities that are unrelated to its core business activities which will not be disposed of as part of this transaction.

Assumptions:

·         There are no unrealised gains in respect of the assets that include in the Balance Sheet of Taxpayer A as at 31 December XXXX.

·         There are no unrealised gains in respect of the assets that include in the Balance Sheet of Taxpayer B as at 31 December XXXX.

·         Any valuations of entities or businesses will be undertaken in accordance with the ATO's 'Market valuation for tax purposes' guidelines.

Relevant legislative provisions

Income Tax Assessment Act 1936 subsection 6(1)

Income Tax Assessment Act 1936 subsection 23AH(3)

Income Tax Assessment Act 1936 paragraph 23AH(3)(a)

Income Tax Assessment Act 1936 paragraph 23AH(3)(b)

Income Tax Assessment Act 1936 paragraph 23AH(3)(c)

Income Tax Assessment Act 1936 subsection 23AH(8)

Income Tax Assessment Act 1936 section 317

Income Tax Assessment Act 1936 subsection 317(1)

Income Tax Assessment Act 1936 section 320

Income Tax Assessment Act 1997 subsection 104-10(1)

Income Tax Assessment Act 1997 subsection 104-10(2)

Income Tax Assessment Act 1997 subsection 104-10(4)

Income Tax Assessment Act 1997 section 110-25

Income Tax Assessment Act 1997 section 855-15

Reasons for decision

Question 1

Summary

In the event that the Taxpayer A makes a capital gain from the disposal of its net business assets (other than the shares in a related party), this gain will be disregarded for the purposes of Part 3-1 of the ITAA 1997 on the basis that it satisfies the requirements of subsection 23AH(3) of the ITAA1936 and none of the exceptions to subsection 23AH(3) of the ITAA1936 apply.

Detailed reasoning

Subsection 104-10(1) of the ITAA 1997 states that CGT event A1 happens if you dispose of a CGT asset. Subsection 104-10(4) of the ITAA 1997 stats that a capital gain is made if the capital proceeds from the disposal of a CGT asset exceed the asset's cost base.

Under the proposed arrangement and based on information provided, Taxpayer A will transfer various assets, used solely in carrying on its business including the goodwill to various entities within the group. The transfer of these various assets will constitute a deemed disposal of the business of Taxpayer A under CGT event A1.

A capital gain is made if the capital proceeds from the disposal of a CGT asset exceed the asset's cost base as set out under section 110-25 of the ITAA 1997. Where the capital proceeds from the transfer exceed the cost base as worked out by Taxpayer A, a capital gain would be realised by Taxpayer A.

However, subsection 23AH(3) of the ITAA 1936 states that a capital gain from a CGT event happening to a CGT asset is disregarded for the purposes of Part 3-1 of the ITAA 1997 if all of the requirements of the subsection are met and the exceptions of subsection 23AH(8) of the ITAA 1936 have no application to limit the exemption in subsection 23AH(3).

Subsection 23AH(3) of the ITAA 1936 provides that a capital gain from a CGT event happening to a CGT asset is disregarded for the purposes of Part 3-1 of the ITAA 1997 if:

·         the gain is made by a company that is a resident;

·         the company used the asset wholly or mainly for the purposes of producing foreign income in carrying on a business at or through a permanent establishment (PE) of the company in a listed country or unlisted country; and

·         the asset is not taxable Australian property.

Subsection 23AH(8) of the ITAA 1936 contains exceptions to subsection 23AH(3) as it provides that subsection (3) does not apply to a capital gain if:

·         PE is in an unlisted country; and

·         the gain is from a tainted asset.

The gain is made by a company that is a resident

Paragraph 23AH(3)(a) of the ITAA 1936 requires the gain to be made by a company that is a resident. Taxpayer A is a resident as defined in subsection 6(1) of the ITAA 1936.

The asset is mainly used for producing foreign income

Paragraph 23AH(3)(b) of the ITAA 1936 requires that the company used the asset wholly or mainly for the purpose of producing foreign income in carrying on a business at or through a PE of the company in a listed country or unlisted country.

Taxation Ruling TR 2002/5 provides the Commissioner's interpretation on the meaning of the phrase 'a place at or through which [a] person carries on any business' in the definition of PE (subsection 6(1) of the ITAA 1936). PE is based on the concept of PE used in Australia's tax treaties and is a reference to a place used for carrying on that person's business activities. That place must have an element of permanence both geographical and temporal (paragraph 9 of TR 2002/5).

Section 320 of the ITAA 1936 defines an 'unlisted country' as being a country that is not a foreign country declared by the regulations to be a listed country for the purposes of Part X of the ITAA 1936. Listed countries includes: Canada, France, Germany, Japan, New Zealand, the United Kingdom and the United States.

Taxpayer A carries on its business through foreign branches in relation to customers based in foreign countries. Each foreign branch is a permanent establishment of Taxpayer A in an unlisted country.

The relevant CGT assets to be disposed of by Taxpayer A were used by Taxpayer A wholly or mainly for the purpose of producing foreign income or with the expectation of producing assessable foreign income at or through a permanent establishment in an unlisted country.

Therefore, paragraph 23AH(3)(b) of the ITAA 1936 is satisfied.

The asset is not taxable Australian property

Section 855-15 of the ITAA 1997 sets out when an asset is taxable Australian property in the five Items contained in the table. Relevantly taxable Australian property includes direct or indirect interests in Australian real property, CGT assets used in carrying on a business in Australia, and mining, quarrying or prospecting rights to minerals, petroleum or quarry materials situated in Australia.

The assets and staff to be transferred are only utilised in Taxpayer A's business carried on at or through branch offices in foreign counties. The interest in the CGT asset held by the foreign branch (the permanent establishment) is not real property situated in Australia or a right relating to minerals or petroleum or quarry materials which are situated in Australia. Therefore, the interest is not taxable Australian property for the purposes of paragraph 23AH(3)(c) if the ITAA 1936.

Is the PE in an unlisted country and the gain from a tainted asset?

As discussed above, the relevant foreign country is an unlisted country, so it is therefore necessary to determine whether the gain is from a tainted asset.

Subsection 317(1) of the ITAA 1936 defines a tainted asset in relation to a company as:

tainted asset , in relation to a company, means:

(a) any of the following:

(i) loans (including deposits with a bank or other financial institution);

(ii) debenture stock, bonds, debentures, certificates of entitlement, bills of exchange, promissory notes or other securities;

(iii) shares in a company;

(iv) an interest in a trust or partnership;

(v) futures contracts;

(vi) forward contracts;

(vii) interest rate swap contracts;

(viii) currency swap contracts;

(ix) forward exchange rate contracts;

(x) forward interest rate contracts;

(xi) life assurance policies;

(xii) a right or option in respect of such a loan, security, share, interest, contract or policy;

(xiii) any similar financial instrument; or

(b) an asset that was held by the company solely or principally for the purpose of deriving tainted rental income; or

(c) an asset other than:

(i) trading stock; or

(ii) any other asset used solely in carrying on a business;

but does not include a commodity investment.

Taxpayer A will be transferring the net business assets relating to the core business carried on in Country X. The transfers will made to different entities and be broken down depending on the region the business relates to, that is, sales relating to customers with close proximity to country H and some other foreign countries.

Paragraph (a) in the definition of tainted asset in subsection 317(1) of the ITAA 1936 is not applicable as the interest in the relevant CGT assets are not assets listed in that paragraph. Paragraph (b) will not apply as the relevant CGT asset is not an asset that was held by Taxpayer A solely or principally for the purpose of deriving tainted rental income. Paragraph (c) will not apply as there are no assets included in the transfer that is not used solely in carrying on a business.

Therefore, the relevant CGT assets are not a tainted asset as defined in subsection 317(1) of the ITAA 1936.

Conclusion

Any capital gain made by Taxpayer A due to the foreign branch's disposal of its interest in the CGT asset (excluding shares to related party) will be disregarded pursuant to subsection 23AH(3) of the ITAA 1936.

Question 2

Summary

In the event that the Taxpayer B makes a capital gain from the disposal of its net business assets this gain will be disregarded for the purposes of Part 3-1 of the ITAA 1997 on the basis that it satisfies the requirements of subsection 23AH(3) of the ITAA1936 and none of the exceptions to subsection 23AH(3) of the ITAA1936 apply.

Detailed reasoning

Subsection 104-10(1) of the ITAA 1997 states that CGT event A1 happens if you dispose of a CGT asset. Subsection 104-10(4) of the ITAA 1997 stats that a capital gain is made if the capital proceeds from the disposal of a CGT asset exceed the asset's cost base.

Under the proposed arrangement and based on information provided, Taxpayer B will transfer various assets, used solely in carrying on its business including the goodwill to various entities within the group. The transfer of these various assets will constitute a deemed disposal of the business of Taxpayer A under CGT event A1.

A capital gain is made if the capital proceeds from the disposal of a CGT asset exceed the asset's cost base as set out under section 110-25 of the ITAA 1997. Where the capital proceeds from the transfer exceed the cost base as worked out by Taxpayer B, a capital gain would be realised by Taxpayer B.

However, subsection 23AH(3) of the ITAA 1936 states that a capital gain from a CGT event happening to a CGT asset is disregarded for the purposes of Part 3-1 of the ITAA 1997 if all of the requirements of the subsection are met and the exceptions of subsection 23AH(8) of the ITAA 1936 have no application to limit the exemption in subsection 23AH(3).

Subsection 23AH(3) of the ITAA 1936 provides that a capital gain from a CGT event happening to a CGT asset is disregarded for the purposes of Part 3-1 of the ITAA 1997 if:

·         the gain is made by a company that is a resident;

·         the company used the asset wholly or mainly for the purposes of producing foreign income in carrying on a business at or through a permanent establishment (PE) of the company in a listed country or unlisted country; and

·         the asset is not taxable Australian property.

Subsection 23AH(8) of the ITAA 1936 contains exceptions to subsection 23AH(3) as it provides that subsection (3) does not apply to a capital gain if:

·         PE is in an unlisted country; and

·         the gain is from a tainted asset.

The gain is made by a company that is a resident

Paragraph 23AH(3)(a) of the ITAA 1936 requires the gain to be made by a company that is a resident. Taxpayer B is a resident as defined in subsection 6(1) of the ITAA 1936.

The asset is mainly used for producing foreign income

Paragraph 23AH(3)(b) of the ITAA 1936 requires that the company used the asset wholly or mainly for the purpose of producing foreign income in carrying on a business at or through a PE of the company in a listed country or unlisted country.

Taxation Ruling TR 2002/5 provides the Commissioner's interpretation on the meaning of the phrase 'a place at or through which [a] person carries on any business' in the definition of PE (subsection 6(1) of the ITAA 1936). PE is based on the concept of PE used in Australia's tax treaties and is a reference to a place used for carrying on that person's business activities. That place must have an element of permanence both geographical and temporal (paragraph 9 of TR 2002/5).

Section 320 of the ITAA 1936 defines an 'unlisted country' as being a country that is not a foreign country declared by the regulations to be a listed country for the purposes of Part X of the ITAA 1936. Listed countries includes: Canada, France, Germany, Japan, New Zealand, the United Kingdom and the United States.

Taxpayer B carries on its business through foreign branches in relation to customers based in foreign countries. Each foreign branch is a permanent establishment of Taxpayer B in an unlisted country.

The relevant CGT assets to be disposed of by Taxpayer B were used by Taxpayer B wholly or mainly for the purpose of producing foreign income or with the expectation of producing assessable foreign income at or through a permanent establishment in an unlisted country.

Therefore, paragraph 23AH(3)(b) of the ITAA 1936 is satisfied.

The asset is not taxable Australian property

Section 855-15 of the ITAA 1997 sets out when an asset is taxable Australian property in the five Items contained in the table. Relevantly taxable Australian property includes direct or indirect interests in Australian real property, CGT assets used in carrying on a business in Australia, and mining, quarrying or prospecting rights to minerals, petroleum or quarry materials situated in Australia.

The assets and staff to be transferred are only utilised in Taxpayer B's business carried on at or through branch offices in foreign counties. The interest in the CGT asset held by the foreign branch (the permanent establishment) is not real property situated in Australia or a right relating to minerals or petroleum or quarry materials which are situated in Australia. Therefore, the interest is not taxable Australian property for the purposes of paragraph 23AH(3)(c) if the ITAA 1936.

Is the PE in an unlisted country and the gain from a tainted asset?

As discussed above, the relevant foreign country is an unlisted country, so it is therefore necessary to determine whether the gain is from a tainted asset.

Subsection 317(1) of the ITAA 1936 defines a tainted asset in relation to a company as:

tainted asset , in relation to a company, means:

(a) any of the following:

(i) loans (including deposits with a bank or other financial institution);

(ii) debenture stock, bonds, debentures, certificates of entitlement, bills of exchange, promissory notes or other securities;

(iii) shares in a company;

(iv) an interest in a trust or partnership;

(v) futures contracts;

(vi) forward contracts;

(vii) interest rate swap contracts;

(viii) currency swap contracts;

(ix) forward exchange rate contracts;

(x) forward interest rate contracts;

(xi) life assurance policies;

(xii) a right or option in respect of such a loan, security, share, interest, contract or policy;

(xiii) any similar financial instrument; or

(b) an asset that was held by the company solely or principally for the purpose of deriving tainted rental income; or

(c) an asset other than:

(i) trading stock; or

(ii) any other asset used solely in carrying on a business;

but does not include a commodity investment.

Taxpayer B will be transferring the net business assets relating to the core business carried on in Country Y. The transfers will made to different entities and be broken down depending on the region the business relates to, that is, sales relating to customers with close proximity to Country Y and some other foreign countries.

Paragraph (a) in the definition of tainted asset in subsection 317(1) of the ITAA 1936 is not applicable as the interest in the relevant CGT assets are not assets listed in that paragraph. Paragraph (b) will not apply as the relevant CGT asset is not an asset that was held by Taxpayer B solely or principally for the purpose of deriving tainted rental income. Paragraph (c) will not apply as there are no assets included in the transfer that is not used solely in carrying on a business.

Therefore, the relevant CGT assets are not a tainted asset as defined in subsection 317(1) of the ITAA 1936.

Conclusion

Any capital gain made by Taxpayer B due to the foreign branch's disposal of its interest in the CGT asset will be disregarded pursuant to subsection 23AH(3) of the ITAA 1936.

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