Edited version of private advice

Authorisation Number: 1051689053593

Date of advice: 28 May 2020

Ruling

Subject: Capital proceeds

Question

Will the $x received by the following entities, be the total amount of capital proceeds for the share transfers in the Company to Company E as trustee for Trust F:

·                     Person A as executor of the estate of Person B

·                     Company D as trustee for the Family Trust?

Answer

Yes

Question 2

Will the life insurance payout received by Person A be included in the amount of capital proceeds received for the share transfers in the Company?

Answer

No

This ruling applies for the following period:

Year ending 30 June 2020

The scheme commences on:

1 July 2019

Relevant facts and circumstances

1.            Person B died on xx/xx/xx.

2.            Person A is the executor of the estate of Person B. Probate of the Estate was granted to Person A on xx.

3.            Person B and Person C were directors in the Company.

4.            The share structure of the Company at the date of death of Person B was as follows:

(a)            Person B owned 25% of the (50) ordinary shares since incorporation. The cost base of these shares is negligible

(b)          the Family Trust owned 25% of the (50) ordinary shares. The cost base of these shares was $xx when acquired

(c)           the remaining 50% of the (100) ordinary shares were owned by Trust F, and

(d)          the Family Trust and Trust F also have two dividend shares each. The dividend shares do not give the holder the right to vote or any entitlement to capital or surplus on winding up of the Company.

5.            A Shareholder Agreement (SA) was entered on xx between Person B, the Family Trust and Trust B and has been subsequently amended.

6.            Clause xx of the SA provides a buy/sell mechanism in the event of death. It specifically provides that on the death of Person B both their shares and those owned by the Family Trust are covered by the buy/sell mechanism. It allows for the Continuing Shareholder the right to buy and the Terminating Shareholder the right to compel the purchase of shares owned by Person A and the Family Trust for the Value less any Proceeds (as defined in the SA).

7.            Clause xx of the SA states:

Each Shareholder (Terminating Shareholder) irrevocably grants to the other shareholders(Continuing Shareholder) an option (Call option) to purchase the whole of the shares of the Terminating Shareholder in the Company pro rata to their existing shareholdings on the death or Permanent Incapacity of the Terminating Shareholder or the Director representing the Terminating Shareholder. In the event of the death or Permanent Incapacity of Person B, each of Person B and the Family Trust will be a Terminating Shareholder under this clause 12.

8.            Clause xx of the SA states:

Person B has taken out and will keep current at the cost of the Company a life insurance policy for the sum of $x million or such other amount as is agreed from time to time, to be reviewed annually (Policy). The parties agree that the Policy may not be for the full Value of the Shares of Person B and the Family Trust, but may be for a lesser sum than full Value.

9.            Person B took out the policy on xx in their name for $x, listing Person A as the sole beneficiary. However, Person B reduced the amount of the life insurance policy from a benefit amount which was $x on xx/xx/xx to $x. Also, the life insurance policy was not at the cost of the Company but rather paid for by Person B personally with Person A as the sole beneficiary. The amount of $x has been paid to Person A.

10.          Informal discussions happened shortly after Person B's death on the continued operation of the Company and the transfer of the shares from the Estate and the Family Trust (the Shares). However, the parties could not agree on the amount to be paid for the shares, as the SA had not been complied with, leading to a Dispute and the parties seeking legal advice.

11.          On xx/xx/xx a conference was held between the parties with no agreement reached.

12.          Numerous correspondence passed between the parties and a second conference was held on xx/xx/xx, this time with the parties legal representatives in attendance, where an in-principle agreement was reached.

13.          A Heads of Agreement (HoA) was signed on xx/xx/xx.

14.          The Company obtained a valuation from xx.

15.          The parties entered into a Deed of Settlement and Release (Deed) that was signed and dated xx/xx/xx. The Purchaser agreed to pay the Estate and the Trust $xx in consideration for the purchase of their shares. The parties also agreed to release each other on the term and conditions contained in the Deed.

16.          In an email sent on xx/xx/xx, the following responses were provided:

·                    the life insurance policy was to be at the cost of the Company, but the payments were treated as a dividend to Person B from the Company meaning Person B actually bore the cost of the premiums

·                    the underlying purpose of the life insurance policy was to provide or at least substantially provide the amount of fund that the Continuing Shareholder would be required to raise in order to buy out the Terminating Shareholder in the event of Person B's death

·                    the life insurance policy was taken out in Person B's name and the beneficiary was Person A, which Person C was not aware of

·                    Person C's position is that the beneficiary should have been the Company or Continuing Shareholder noting the Value for the shares to be paid by the Continuing Shareholder is to be reduced by the amount of the Proceeds

·                    the policy was an indexed policy that increased automatically each year, and by xx/xx/xx was valued at $x

·                    although Person B wanted to cancel the policy, Person C was not in agreement, and resulting in the policy being reduced to $x - Person B believed the premiums were excessive and they had no known health issues

·                    Person C was not required to take out a life insurance policy, as they would not have been able to due to medical reasons

·                    it was not in dispute that Trust F wanted to buy the Company shares, it was the amount to be paid that gave rise to the dispute

·                    on xx/xx/xx a meeting between the parties was held to discuss the continued operation of the Company and the terms of the SA. Whilst the parties could not reach an agreement, it was agreed that Person C was to get legal advice in relation to their position.

·                    Person C subsequently engaged lawyers, who at the conference on xx/xx/xx set out their position, that included the following:

(a)          Person B was in breach of the SA in two separate ways:

(i)            the amount of the life insurance amount should not have been below $x, and

(ii)           the way the life insurance policy was structured did not benefit the Company or the Continuing Shareholder

(b)          Person C was of the genuine belief that the life insurance policy was being paid by the Company and did not know that it was being accounted as dividends to Person B

·                    at this conference, an in-principle agreement was reached to avoid the time and expense of the litigation of the dispute. This is documented in the HoA. Following the HoA the valuation of the shares and tax advice was subsequently obtained. After that was done, a binding agreement was formalised in a Deed of Settlement and Release (Deed).

·                    the negotiated settlement of the dispute provided that the Estate and the Family Trust received a combined $x consideration for the transfer of the shares to Trust F and a release from any claims.

·                    the market value of the Shares was determined by an independent accountant to be $x.

17.          On xx/xx/xx the parties entered into the Deed that included the following:

(a)           Trust F wished to exercise its right to acquire the Shares pursuant to the SA.

(b)          the parties have been in Dispute as to the amount to be paid by Trust F to acquire the Shares from Person B's Estate and the Family Trust

(c)           the parties wished to resolve the Dispute as follows:

(i)         in consideration for payment of the total Settlement Amount by Trust F to the Estate and Family Trust, the Estate and Family Trust have agreed to sell and Trust F has agreed to buy the Shares

(ii)           the parties have agreed to release each other on the terms and conditions contained in this Deed.

(d)          The Settlement Amount means the sum of $x be apportioned as follows:

Estate 50 ordinary shares $x

Family Trust 50 ordinary shares $x, and

2 dividend shares $x

(e)          Clause xx of the Deed states that with effect from the Effective Date each of the Estate and the Family Trust will sell and Trust F will buy their respective Shares as apportioned in the Settlement Amount

(f)            Clause xx of the Deed states that payment of the Settlement Amount plus any dividends will be accepted by each of the Estate and the Family Trust in full and final settlement of the Dispute including without limitation any monies payable by Trust F in respect of the Shares.

(g)          under Clause xx of the Deed all parties agreed to forever release each other from all Claims made at any time or in any way relating to the Company and the Shares.

18.          The Shares were transferred under the terms and conditions of the Deed and not by exercising the option under the SA.

Information provided

19.          You have provided the following documents in relation to the ruling request:

(a)          your private ruling application received on xx, and

(b)          supplementary information provided via email.

Relevant legislative provisions

Income Tax Assessment Act 1936, Former Part IIIA

Income Tax Assessment Act 1997, Subsection 104-25(1)

Income Tax Assessment Act 1997, Section 104-10

Income Tax Assessment Act 1997, Subsection 116-20(1)

Income Tax Assessment Act 1997, Subsection 118-300(1)

Income Tax Assessment Act 1997, Subsection 118-300(1A)

ATO view documents

Taxation Ruling TR 95/35, Income tax: capital gains: treatment of compensation receipts

Reasons for decision

All legislative references are to the Income Tax Assessment Act 1997 (ITAA 1997) unless otherwise stated.

Question 1

Will the $x received by the following entities, be the total amount of capital proceeds for the share transfers in the Company to Company E as trustee for the Trust F:

·                     Person A as executor of the estate of Person B

·                     Company D as trustee for the Family Trust?

Summary

The $x received by Person B and the Family Trust will be the total amount of capital proceeds for the transfer of the shares in the Company held by them to Trust F.

Detailed reasoning

1.            Taxation Ruling TR 95/35 - Income tax: capital gains: treatment of compensation receipts (TR 95/35) considers the tax treatment of compensation receipts. Paragraph 3 of TR 95/35 states:

A compensation receipt, or compensation, includes any amount (whether money or other property) received by a taxpayer in respect of a right to seek compensation or a cause of action, or any proceeding instituted by the taxpayer in respect of that right or cause of action, whether or not:

·                    in relation to any underlying asset;

·                    arising out of Court proceedings; or

·                    made up of dissected amounts.

The right to seek compensation is the right of action arising at law or in equity and vesting in the taxpayer on the occurrence of any breach of contract, personal injury or other compensable damage or injury. The right to seek compensation is an asset for the purposes of Part IIIA. The right to seek compensation is acquired at the time of the compensable wrong or injury and includes all of the rights arising during the process of pursuing the compensation claim. The right to seek compensation is disposed of when it is satisfied, surrendered, released or discharged.

2.            In particular, TR 95/35 considers whether an amount of compensation should be included in assessable income of the recipient under the former Part IIIA of the Income Tax Assessment Act 1936.

3.            According to Clause xx of the Deed, payment of the Settlement Amount was made by the Estate and Family Trust in full and final settlement of the Dispute including without limitation any monies payable by Trust F in respect of the Shares.

4.            As the Settlement Amount was paid in respect of an underlying asset, being the Shares, the full amount received will be treated as capital proceeds for the sale of shares in accordance with subsection 116-20(1).

5.            Subsection 116-20(1) states that the capital proceeds from a CGT event are the total of:

a)            The money you have received, or are entitled to receive, in respect of the event happening; and

b)            The market value of any other property you have received, or are entitled to receive, in respect of the event happening (worked out as at the time of the event).

6.            When the Estate and the Family Trust transferred their shares to Trust F pursuant to the Deed, CGT event A1 in section 104-10 happened.

Question 2

Will the life insurance payout received by Person A be included in the amount of capital proceeds received for the share transfers in the Company?

Summary

The $x received by Person A as the beneficiary of Person's B life insurance policy will not be included in the capital proceeds for the share transfers.

Detailed reasoning

7.            The surrender or discharge of a life insurance policy will result in CGT event C2 in subsection 104-25(1) happening.

8.            Subsection 118-300(1) disregards any capital gain or capital loss made where a CGT event happens in relation in relation to a taxpayer's interest in rights under a policy of insurance on the life of an individual or an annuity instrument if the taxpayer:

·                     is the original owner of the policy or instrument (other than the trustee of a complying superannuation fund), or

·                     acquired the interest in the policy or instrument for no consideration, or

·                     is the trustee of a complying superannuation entity for the income year in which the CGT event happened.

9.            Under subsection 118-300(1A) where a trustee then makes a payment to a beneficiary in respect of the policy or instrument, any capital gain or capital loss made by the beneficiary is also disregarded. This exemption also applies where a payment of the proceeds of a life insurance policy is made by an executor of a deceased estate to a beneficiary.

10.          Clause xx of the SA required Person B to take out a life insurance policy which would be paid for by the Company. Whilst not stated in the SA, it was expected that the Company would be the beneficiary, to enable the purchase of Person B's shares upon their death.

11.          Instead Person B took out the life insurance policy on xx/xx/xx in their name, listing Person A as the sole beneficiary.

12.          Whilst the Company made the actual payments of the premiums, such payments were treated as a dividend to Person B from the Company, meaning Person B actually bore the cost of the premiums.

13.          Person B died on xx/xx/xx. At the time of death, the policy insured amount was $x and this amount was paid to Person A as the sole beneficiary of the policy.

14.          This payment was not connected with the sale of the Shares in the Company to Trust F capital proceeds for the sale of the Shares were determined in accordance with the Deed.

15.          As such, the $x life insurance payment made to Person A is not capital proceeds in relation to the sale of the Shares and subsection 118-300(1) will apply to disregard the capital gain made by Person A in relation to this payment.

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