Edited version of private advice

Authorisation Number: 1051666608270

Date of advice: 7 May 2020

Ruling

Subject: Distribution from a company in voluntary liquidation

Question 1

Would the Commissioner be satisfied or find it reasonable to assume that, for the purposes of Division 149 of the Income Tax Assessment Act 1997 (ITAA 1997), the majority of underlying interests held in the pre-CGT assets of the Company have been maintained?

Answer

Yes

Question 2

Will the Commissioner accept that the capital gain from the sale of the Property is disregarded as it is was acquired pre 20 September 1985?

Answer

Yes

Question 3

Will the disposal of the refurbishment result in a capital gain under section 100-45 of the Income Tax Assessment Act 1997?

Answer

No

Question 4

Is the distribution to shareholders in the course of the member's voluntary winding up included in the assessable income of the shareholders in the form of a dividend under subsection 47(1) of the Income Tax Assessment Act 1936 (ITAA 1936) for the purposes of section 44 of the ITAA 1936?

Answer

No

Question 5

Was the sale of the Property a GST-free supply of a going concern for the purposes of section 38-325 of the A New Tax System (Goods and Services Tax) Act 1999 (GST Act)?

Answer

Yes

This ruling applies for the following period:

Year ended 30 June 20XX

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

Taxpayer's land and building

You are registered for Goods and Services Tax (GST).

You acquired land and a building (the Property) pre-CGT.

The Property comprised land and a commercial building.

The Property was used for the purpose of producing rental income at all times from the date of acquisition by your up until the commencement of the post-CGT Refurbishment. Over the years, portions of the building were leased to various arm's length tenants.

You commenced a major Post-CGT refurbishment of the building situated on the land owned by you.

The building was vacated so as to permit construction of the Refurbishment.

After completion of the Refurbishment, the building was reopened for the leasing of the redeveloped floors or parts thereof to third party tenants.

New third party leases for separate portions of the new building were entered into.

On or about XX XXXX XXXX, you acquired the Laneway adjoining the Property (excluding GST and other settlement adjustments). No capital improvement was made to the laneway. The laneway provided access to the Property.

By contract of sale dated XX XXXX XXXX, made between you (as Vendor) and purchaser and settled on XX XXXX XXXX, you sold Post-CGT each of

·         the Property as a going concern.

·         The laneway as a taxable supply.

The laneway was an asset used by you in carrying on the commercial leasing business within the Property. It was supplied to the Purchaser to enable the purchaser to continue the operation of the business acquired from you.

After the completion of the Refurbishment, you continuously carried on the business of renting out the building on the Property under commercial leases to third parties until the date of settlement of the sale.

The Contract of Sale provides for the sale to be subject to existing tenancies.

At settlement, all the building levels were occupied by tenants.

The refurbishment is to be considered a separate asset and is deemed to have been acquired by you on the date the construction contract was executed (section 100-20(3) ITAA 1997).

Shareholdings

The issued capital of you comprises X ordinary shares each fully paid to $X per share.

You's issued capital has, at all material times since a date pre-CGT, been beneficially owned by Company X.

The issued capital of Company X comprises X Ordinary Shares each fully paid to $X per share.

The Company X issued capital has at all material times been held by Company Z in its capacity as Trustee of the W Trust created by deed dated pre-CGT

Trust deed

The list of beneficiaries has not been changed since the creation of the W Trust.

There is no person existing capable of appointing additional beneficiaries in terms of the Trust Deed; so the range of Beneficiaries as detailed in the Schedule to the Trust Deed has been locked in since XX XXXX XXXX.

The directors of Company Z have decided that all distributions of capital from the W Trust are to be made in a manner consistent with the provisions of the Will of their mother, and in the proportions stated in that Will (the Will Concept).

Company Z has, at all relevant times since the creation of the W Trust, administered the W Trust solely for the benefit of the same family.

Distribution to Company X

The liquidator proposes to distribute, by way of a specific liquidator's capital distribution, the amount of $X out of the Capital Profit Reserve Pre 1985 account to Company X.

You will be deregistered in terms of subsection 509(5) of the Corporations Act 2001.

Relevant legislative provisions

Income Tax Assessment Act 1936 section 47

Income Tax Assessment Act 1936 subsection 47(1)

Income Tax Assessment Act 1936 subsection 47(1A)

Income Tax Assessment Act 1997 section 100-45

Income Tax Assessment Act 1997 paragraph 104-10(5)(a)

Income Tax Assessment Act 1997 section 104-25

Income Tax Assessment Act 1997 Division 149

Income Tax Assessment Act 1997 subsection 149-15(1

Income Tax Assessment Act 1997 subsection 149-15(2)

Income Tax Assessment Act 1997 subsection 149-15(3)

Income Tax Assessment Act 1997 section 149-25

Income Tax Assessment Act 1997 subsection 149-30(1)

Income Tax Assessment Act 1997 subsection 149-30(2)

Income Tax Assessment Act 1997 section 149-50

A New Tax System (Goods and Services Tax) Act 1999 section 38-325.

A New Tax System (Goods and Services Tax) Act 1999 subsection 38-325(1).

A New Tax System (Goods and Services Tax) Act 1999 subsection 38-325(2).

A New Tax System (Goods and Services Tax) Act 1999 section 195-1

Reasons for decision

Detailed reasoning

Question 1: Application of Division 149

Division 149 of the Income Tax Assessment Act 1997 outlines the circumstances when an asset acquired before 20 September 1985 stops being a pre-CGT asset.

As the company is not a public entity or any other entity listed in section 149-50 of the ITAA 1997, Subdivision 149-C of the ITAA 1997 will apply: pursuant to section 149-25 of the ITAA 1997.

Subsection 149-30(1) of the ITAA 1997 provides 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.

This means that ultimate owners who held majority underlying interests in an asset immediately before 20 September 1985 must retain those interests after that date, otherwise Division 149 of the ITAA 1997 will operate to convert the asset into a post-CGT asset.

Under subsection 149-30(2) of the ITAA 1997, if the Commissioner is satisfied, or thinks it reasonable to assume, that at all times on and after 20 September 1985 and before a particular time majority underlying interests in the asset were had by ultimate owners who had majority underlying interests in the asset immediately before that day, subsection 149-30(1) of the ITAA 1997 apply as if that were in fact the case.

Subsection 149-15(3) of the ITAA 1997 states that:

An ultimate owner is:

(a)  an individual; or

(b)  a company whose *constitution prevents it from making any distribution, whether in money, property or otherwise, to its members; or

(c)   ...

(d)  ...

(e)  ...

(f)    ...

As a result, this definition does not include trusts or companies who pay dividends to their members.

Subsection 149-15(2) of the ITAA 1997 states that:

An underlying interest in a *CGT asset is a beneficial interest that an *ultimate owner has (whether directly or *indirectly) in the asset or any *ordinary income that may be *derived from the asset.

Subsection 149-15(1) of the ITAA 1997 states that:

Majority underlying interests in a *CGT asset consist of:

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

(b)  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.

Majority underlying interests immediately before 20 September 1985

Overview

Pursuant to subsection 149-15(1) of the ITAA 1997, the company is required to identify the ultimate owners who held, directly or indirectly, at least 50% of the beneficial interests in:

(a)  its pre-CGT assets, and

(b)  any ordinary income that could be derived from the assets.

The term 'beneficial interest' is not defined in the ITAA 1997.

Under its ordinary meaning, a shareholder would not have legal or equitable interests in the assets of the company until the trustee exercises its discretion to distribute income or capital to that beneficiary: pursuant to Charles v. Federal Commissioner of Taxation (1954) 90 CLR 598; 10 ATD 328; 6 AITR 85.

Despite this, the ATO has formed the view in NTLG CGT Sub-Committee Meeting (dated 1 December 1993) that section 160ZZS of the Income Tax Assessment Act 1936 (ITAA 1936) necessarily supplants ordinary legal concepts of beneficial interests in an asset. Section 160ZZS of the ITAA 1936 is the predecessor to Division 149 of the ITAA 1997.

For the purposes of section 160ZZS of the ITAA 1936, a shareholder may be treated as having a beneficial interest in the company's assets: pursuant to Case Y59 91 ATC 502; AAT Case 7529 (1991) 22 ATR 3532.

Similarly, a beneficiary of a discretionary trust is treated as having a beneficial interest in the assets of a trust for the purposes of section 160ZZS of the ITAA 1936.

Taxation Ruling IT 2340 Income tax: capital gains: deemed acquisition of assets by a taxpayer after 19 September 1985 where a change occurs in the underlying ownership of assets acquired by the taxpayer on or before that date (IT 2340) reflects an approach of 'looking through' interposed entities to determine which natural persons hold the beneficial interests. Where shares in a company are held by the trustee of a discretionary trust, the shares are not beneficially owned by any persons. This creates difficulties when assessing whether the majority underlying beneficial interest in an asset is maintained. It states at paragraph 5 that it will be relevant to take into account the way in which the discretionary powers of the trustee are exercised when considering whether majority underlying interests in a pre-CGT asset have been maintained.

For example, where a trustee continues to administer a trust for the benefit of a certain group of beneficiaries, IT 2340 states that section 160ZZS of the ITAA 1936 will not apply. This is merely because distributions to family members who are beneficiaries are made in such amounts and to such of those beneficiaries as the trustee determines in the exercise of his discretion. In such a case, the Commissioner would find it reasonable to assume that for all practical purposes the majority underlying interests have not changed.

In this regard, paragraph 6 of IT 2340 requires the taxpayer to show that the trustee has administered the trust for the benefit of its members, for example family members who are beneficiaries, at all times during the relevant years of income. Furthermore, the trustee must not have exercised discretionary powers to appoint beneficiaries or amend the trust deed that would result in a practical change of 50% or more of the underlying interests in the trust assets (paragraph 8), such as where the members of a new family are substituted as recipients of distributions from the trust in place of persons who were formerly the object of such distributions.

Taxation Ruling IT 2340 was written with reference to section 160ZZS of the ITAA 1936 (the section that preceded parts of Division 149). It has equal application to the current provisions dealing with changes to underlying majority interests in pre-CGT assets.

The NTLG CGT Sub-committee minutes - 28 November 2001 considered the term 'family' for the purposes of Taxation Ruling IT 2340:

Continuity of ownership test and growth of family

The ICAA raised the following issue:

In applying IT 2340, what is meant by 'one family' and by 'a new family'? What changes to the composition of the family (for example, births, deaths, marriages, divorces, and adoptions) affect this issue? What factors does the Commissioner take into account so that he or she can be satisfied or think it reasonable to assume that the majority underlying interests test has been met?

The ATO stated that the issues like these arise occasionally, but the propositions in Taxation Ruling IT 2340 seem to be generally accepted. Thus, no comprehensive administrative policy has been developed on these issues. What constitutes a member of a particular 'family' will require consideration of the facts of particular cases. The ATO considers that what is contemplated is narrower that a 'relative' (e.g. a distant relative would not normally be thought to qualify), but equally, the concept of 'family' is not intended to be limited to the 'nuclear' family (i.e., father, mother and children). What is often described as an 'extended' family (i.e., including grandparents, children, grandchildren and their spouses) would ordinarily qualify as a 'family' for these purposes. Also, if distributions are made to post-19 September 1985 additions to a family (for example, the birth of new family members and new persons joining a family through marriage), the 'family' distribution criteria would ordinarily still be satisfied.

We consider that at all times the trust deed has continued to benefit the same family as outlined in IT 2340 and is consistent with the response of the ATO in NTLG CGT Sub-committee minutes of 28 November 2001 and that majority underlying interests in the trust assets will not change as a result. The Commissioner is satisfied that at all times on or after 20 September 1985 the majority underlying interests in the asset were had by ultimate owners who had majority underlying interests in the asset immediately before that day.

Therefore assets of the Trust acquired before 20 September 1985 will not stop being 'pre-CGT assets' under Division 149 of the ITAA 1997. This means that the property held by you will remain pre-CGT.

Question 2: Pre-CGT status of asset

A capital gain or loss you make is disregarded if you acquired the asset before 20 September 1985 (paragraph 104-10(5)(a) of the ITAA 1997).

The Property was purchased before 20 September 1985. As per the analysis in question 1, the property will remain pre-CGT. Therefore when it was disposed, any capital gain or loss would be disregarded.

Question 3: Disposal of refurbishment

Section 100-45 of the Income Tax Assessment Act 1997 (ITAA 1997) provides the process required to calculate the capital gain or loss made from most CGT events. At step 7 it provides,

If the capital proceeds are less than the cost base but more than the reduced cost base, you have neither a capital gain nor a capital loss.

In your case, the capital proceeds you received were less than the cost base of the asset. Additionally, the capital proceeds were more than the reduced cost base of your property.

Therefore, in accordance with section 100-45 of the ITAA 1997, you have made neither a capital gain nor a capital loss.

Question 4: Liquidator Distribution

At common law, a distribution to a shareholder by a liquidator is capital, not income, in the hands of the shareholder since it is a realisation of the shareholder's interest in the company: FC of T (NSW) v Stevenson (1937) 4 ATD 415; (1937) 59 CLR 80; FC of T v Blakely (1951) 9 ATD 239 at 245, 247; (1951) 82 CLR 388 at 402, 407; FC of T v Brewing Investments Ltd [2000] FCA 920; 2000 ATC 4431 per Hill J at 18 - 19

Liquidator distributions from the capital reserve account sourced from assets acquired prior to 20 September 1985 are, in some circumstances, not taxable as either a deemed dividend under section 47 of the ITAA 1936, or a net capital gain under section 104-25 of the ITAA 1997. If the assets were acquired prior to 20 September 1985 and a capital gain is disregarded, then these assets maintain the tax-free status of the distribution from the capital profits reserve account.

Archer Bros Pty Ltd (In Vol Liq) v. FCT (1953) 90 CLR 140; 27 ALJ 353; 10 ATD 192 (Archers Case) discusses distributions. In a joint judgement, the Full High Court of Australia in Archers Case observed by way of obiter dicta:

By a proper system of bookkeeping the liquidator, in the same way as the accountant of a private company which is a going concern, could so keep his accounts that...distributions could be made wholly and exclusively out of...particular profits...or income...'

Taxation Determination TD 95/10 Income tax: what is the significance of the Archer Brothers principle in the context of liquidation distributions? discusses the significance of the "Archer Brothers principle" in the context of liquidation distributions:

The observations in Archers Case have given rise to what is known as the Archer Brothers principle. The principle is that if a liquidator appropriates a particular fund of profit or income in making a distribution, that appropriation ordinarily determines the character of the distributed amount for the purposes of the Income Tax Assessment Act. Generally, a liquidator may rely on the Archer Brothers principle, except where a specific provision produces a different result.

Archers Case refers to 'profits' or 'income'. However, if a liquidator ostensibly distributes an amount representing capital actually contributed by shareholders, we accept that the distribution is treated as a non-dividend return of capital.

Provided the liquidator is able to identify the source from which a particular distribution is made, we will accept a liquidators nominated appropriation. For example, identifying pre-CGT non-assessable profits separately to post-CGT capital gains.

If a liquidator can identify the source of funds distributed, then those funds retain the character of the source. So, a pre-CGT gain on disposal of a building would remain pre-CGT when it was distributed and would therefore be tax free to the shareholders.

Section 47 of the ITAA 1936 specifically deems certain amounts to be dividends paid to the shareholders out of the profits derived by the Company.

Specifically, subsection 47(1) of the ITAA 1936 provides that:

Distributions to shareholders of a company by a liquidator in the course of winding-up the company, to the extent to which they represent income derived by the company (whether before or during liquidation) other than income which has been properly applied to replace a loss of paid-up share capital, shall, for the purposes of this Act, be deemed to be dividends paid to the shareholders by the company out of profits derived by it.

The use of the term "income" in the context of subsection 47(1) of the ITAA 1936 has been interpreted in Gibb v FCT (1966) 118 CLR 628 as meaning income according to ordinary concepts rather than "assessable income". Hence, amounts that are deemed to be assessable income but are not of an income or revenue character are not considered, for the purposes of subsection 47(1) to be "income".

In this case, an interim distribution consisting entirely of a disregarded pre-CGT capital gain on the sale of the property will be distributed to the shareholders as part of a member's voluntary liquidation.

Consequently, the amount of the distributions to the shareholders, as calculated under subsection 47(1A) of the ITAA 1936, are nil and there will not be any assessable income under subsection 47(1) of the ITAA 1936 for the purposes of section 44 of the ITAA 1936.

Question 5: Going Concern

A supply of a going concern is GST-free where it meets the requirements specified in subdivision 38-J of the A New Tax System (Goods and Services Tax) Act 1999 (GST Act).

Subsection 38-325(1) of the GST Act provides that a 'supply of a going concern' is GST-free if:

·         the supply is for consideration

·         the recipient is registered or required to be registered for GST, and

·         the supplier and the recipient have agreed in writing that the supply is of a going concern.

The term 'supply of a going concern' is defined in subsection 38-325(2) of the GST Act. Subsection 38-325(2) of the GST Act provides that:

A supply of a going concern is a supply under an arrangement under which:

(a) the supplier supplies to the *recipient all of the things that are necessary for the continued operation of an *enterprise; and

(b) the supplier carries on, or will carry on, the enterprise until the day of the supply (whether or not as part of a larger enterprise carried on by the supplier).

*The asterisked terms are defined in section 195-1 of the GST Act.

Goods and Services Tax Ruling GSTR 2002/5 Goods and services tax: when is a supply of a going concern GST-free? (GSTR 2002/5) provides the Commissioner's view on GST-free supplies of going concerns.

Paragraph 29 of GSTR 2002/5 explains that subsection 38-325(2) of the GST Act requires the identification of an enterprise that is being carried on by the supplier (the 'identified enterprise').

Paragraphs 38-325(2)(a) and (b) of the GST Act set out the conditions that must be satisfied in relation to an identified enterprise.

In this case, the 'identified enterprise' is a leasing enterprise. You (the vendor) has been operating a leasing enterprise in respect of the refurbished property. It is this leasing enterprise that the vendor will need to carry on until the day of the supply and for which the vendor must supply all of the things that are necessary for its continued operation in order to satisfy the requirements of subsection 38-325(2) of the GST Act.

All of the things that are necessary for the continued operation of a leasing enterprise include the supply of the property and the covenants. Therefore, for the continued operation of your leasing enterprise, it will be necessary to supply the property with the leasing covenants.

On the facts of this case, you supplied all the things that are necessary for the continued operation of the leasing enterprise when the Property was sold to the purchaser subject to the tenancies and leases. Consequently, the sale of the Property with the leases intact constitutes a supply of a going concern as the requirements of subsection 38-325(2) of the GST Act will be satisfied.

From the information provided, the requirements of subsection 38-325(1) of the GST Act will also be satisfied. Therefore, the supply of the Property will be a GST-free supply of a going concern under section 38-325 of the GST Act.

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