Edited version of your private ruling

Authorisation Number: 1051804911661

Date of advice: 19 February 2021

Ruling

Subject: Application of Division 149

Question 1

In accordance with subsection 149-30(1) of the Income Tax Assessment Act 1997 (the ITAA 1997) was there any point in time from 20 September 1985 to XX/YY/2020 at which the majority underlying interests in the pre-CGT assets of Company A (the Taxpayer) were not held by persons who, immediately before 20 September 1985, held the majority underlying interests in those assets?

Answer

No

Question 2

Will the Commissioner be satisfied that in accordance with subsection 149-30(1) of the ITAA 1997 the acquisition of Company E, the holder of 50% of the shares in the Taxpayer, by Trust A will result in the majority underlying interests held in the pre-CGT assets of the Taxpayer not being maintained such that the pre-CGT assets of the Taxpayer will stop being pre-CGT assets?

Answer

Yes

Question 3

Will the Commissioner be satisfied that in accordance with section 149-35 of the ITAA 1997 the first element of the cost bases of the Taxpayer's assets that stopped being pre-CGT assets upon the change of ownership of Company E will be the market value at the date they ceased being pre-CGT assets?

Answer

Yes

This ruling applies for the following period:

1 July 20XX to 30 June 20XX

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

Current and future ownership of Group

The current shareholders of Company A (the Taxpayer) are Company D and Company E which hold their shares legally and beneficially.

The current shareholder of Company D is Mr A.

Prior to XX/YY/2020 the shares in Company E were owned by Ms B.

The Taxpayer beneficially and legally owns the shares in Company B.

Ms B sold her shares in Company E to Trust A, a discretionary trust. This transaction was executed on XX/YY/20XX.

Mr A is a beneficiary of Trust A. Ms B is not a beneficiary of Trust A.

Following the acquisition of Company E, Mr A and his family between them directly and indirectly hold 100% of the B Group.

Group ownership history

Company A

On AA/BB/19XX, the Taxpayer was incorporated. It was initially owned by Mr A's father and mother.

The Taxpayer was incorporated to create a family holding company for the family business.

Mr A's father passed away on BB/CC/1994 and his shares in the Taxpayer passed to Mr A's mother.

Mr A's mother passed away on CC/DD/19XX and her shares in the Taxpayer passed to her three children (Mr A, Ms B, and Mr E) equally.

On EE/FF/20XX Mr A and Ms B acquired Mr E's interest in the Taxpayer.

On FF/GG/20XX Mr A incorporated Company D and transferred his interests in the Taxpayer to this entity. The constitution of Company D does not prevent it from making distributions to members.

On FF/GG/20XX Ms B incorporated Company E and transferred her interests in the Taxpayer to this entity. The constitution of Company E does not prevent it from making distributions to members.

Company B

Company B was incorporated on HH/II/19XX.

The shares in Company B were held equally by the Taxpayer and Company F, which was owned by Mr F.

Accordingly, the beneficial ownership of the shares in Company B was held by the Taxpayer from before 20 September 1985 until today.

On JJ/KK/19XX the shares held by Company F were bought back by Company B and cancelled.

Additional facts

All shareholders have always been Australian resident taxpayers whilst holding their shares in the Taxpayer.

Relevant legislative provisions

Section 149-10 of the Income Tax Assessment Act 1997

Section 149-15 of the Income Tax Assessment Act 1997

Subsection 149-30(1) of the Income Tax Assessment Act 1997

Subsection 149-30(5) of the Income Tax Assessment Act 1997

Former Subsection 160ZZS(1) of the Income Tax Assessment Act 1936

Former Subsection 160ZZS(2) of the Income Tax Assessment Act 1936

Former Subsection 160ZZS(3) of the Income Tax Assessment Act 1936

Former Section 160ZZRU of the Income Tax Assessment Act 1936

Reasons for decision

Question 1

Summary

In accordance with subsection 149-30(1) of the ITAA 1997 there was no point in time from 20 September 1985 to XX/YY/2020 at which the majority underlying interests in the pre-CGT assets of the Taxpayer were not held by persons who, immediately before 20 September 1985, held the majority underlying interests in those assets.

Detailed reasoning

Section 149-10 of the ITAA 1997 states;

A CGT asset that an entity owns is a pre-CGT asset if, and only if:

(a) the entity last acquired the asset before 20 September 1985; and

(c) the asset has not stopped being a pre-CGT asset of the entity because of this Division.

Essentially, a CGT asset acquired before 20 September 1985 remains a pre-CGT asset if the majority underlying interests in the asset have not changed since 20 September 1985. Where a change in the majority underlying interests occurs the CGT asset is deemed to be acquired after 19 September 1985, under either Division 20 of the Income Tax Assessment Act 1936 (ITAA 1936) (income years prior to the 19XX income year) or Division 149 of the ITAA 1997 (19XX income year and succeeding income years).

The Taxpayer's major asset is its shareholding in Company B in which it acquired a beneficial interest before 20 September 1985.

The rulee is not a public company. Therefore former subsection 160ZZS(1) of the ITAA 1936 will apply for income years up to and including the 1998 income year and Subdivision 149-B will apply for income years after the 19XX income year.

Under the factual test in subsection 149-30(1) of the ITAA 1997 an asset stops being a pre-CGT asset at the earliest time when the majority underlying interests in the asset were not held by the ultimate owners who held majority underlying interests in the asset immediately before 20 September 1985.

The meaning of 'majority underlying interests' in a CGT asset is defined in subsection 149-15(1) of the ITAA 1997 as more than 50% of:

(a)the beneficial interests that 'ultimate owners' hold (whether directly or indirectly) in the asset; and

(b)the beneficial interests that 'ultimate owners' hold (whether directly or indirectly) in any income that may be derived from the asset.

Subsection 149-15(2) defines an underlying interest in a CGT asset as:

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

An ultimate owner is defined in subsection 149-15(3) to include an individual or a company whose constitution prevents it from making any distribution, whether in money, property or otherwise to its members.

Subsections 149-15(4) and (5) provide that an ultimate owner has an indirect beneficial interest in a CGT asset of another entity if he/she/it would receive for his/her/its own benefit any capital or ordinary income distributed by the entity through interposed entities (e.g. companies, partnerships or trusts).

The expression 'beneficial interests' as used in the definition of majority underlying interests is not itself defined. In general law, a shareholder does not have any legal or equitable interest in the assets of a company. Thus, it would be difficult to see how an asset of a company can satisfy the majority underlying interests test and remain a pre-CGT asset.

Under subsection 149-30(2), if the Commissioner is satisfied, or thinks it reasonable to assume, that the majority underlying interests in the asset have not changed up to a particular time, then subsections 149-30(1) and (1A) apply and the asset continues to be a Pre-CGT Asset.

Assistance is provided in Income Tax 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)where the terms 'underlying interest' and 'majority underlying interest' as used in section 160ZZS of theITAA 1936 are discussed.

IT 2340 states:

2. The terms "underlying interest" and "majority underlying interests", on the basis of which the provision operates, have the same meanings as they have in Subdivision G of Division 3 of Part III of the Act - which deals with the income tax treatment of interest in relation to "negatively geared" investments in rental property. In both cases (and like provisions of the Act concerned with the measurement of ownership interests) underlying interests in relation to the assets concerned mean beneficial interests held by natural persons, whether directly or through one or more interposed companies, partnerships or trusts. The clear policy of the law thus permits and requires that, for the purposes of the relevant provisions, chains of companies, partnerships and trusts are to be "looked through" in order to determine whether there has been a change in the effective interests of natural persons in the assets [emphasis added].

Section 357-85 of Schedule 1 of the Taxation Administration Act 1953 provides that if the Commissioner has made a ruling about a relevant provision and that provision is re-enacted or remade, the ruling is taken to be about the re-enacted or remade provision, insofar as the new law expresses the same ideas as the old law. Section 357-85 applies to all rulings, including public rulings (paragraphs 49 to 50 of Taxation Ruling TR 2006/10 Public Rulings). As former section 160ZZS expresses the same ideas as Division 149, IT 2340 equally applies to Division 149.

Applying the 'look through' approach for the purposes of Division 149, a shareholder may be treated as having a beneficial interest in the company's assets. This approach has been supported by the Administrative Appeals Tribunal in AAT case 7529 (1991) 22 ATR 3532, Case Y59 91 ATC 502.

      i.        1994 - Death of Mr A's Father

As this event occurred in 19XX, in order to address subsection 149-10(b) we need to consider former subsection 160ZZS(1) of the Income Tax Assessment Act 1936 (ITAA1936) which in 1994 was a transitional provision. It stated:

For the purposes of the application of this Part in relation to a taxpayer, an asset acquired by the taxpayer on or before 19 September 1985 shall be deemed to have been acquired by the taxpayer after that date unless the Commissioner is satisfied, or considers it reasonable to assume, that, at all times after that date when the asset was held by the taxpayer, majority underlying interests in the asset were held by natural persons who, immediately before 20 September 1985, held majority underlying interests in the asset.

Former subsection 160ZZS(3) of the ITAA 1936 defined majority underlying interests when applying 160ZZS(1) as having the same meaning as in Subdivision 3G of Part III.

Majority underlying interests was defined in former subsection 82KZC(1) of the ITAA 1936 to mean more than one-half of:

(a)       The beneficial interests that natural persons hold (whether directly or through one or more interposed companies, partnerships or trusts) in the property, and

(b)       The beneficial interests held by natural persons (whether directly or through one or more interposed companies, partnerships or trusts) in any income that may be derived from the property.

Former subsection 160ZZS(2) of the ITAA 1936 (the transitional provision applicable in 1994 and the equivalent provision to subsections 149-30(3) and 149-30(4) of the ITAA 1997) provides:

For the purposes of this section, where, by reason of the death of a person, a natural person acquires a percentage (in this subsection referred to as the "acquired percentage") of the underlying interests in an asset, the natural person shall be deemed to have held (in addition to any other part of the total underlying interest that the person held or is deemed to have held), at any time when the deceased person held a percentage (in this subsection referred to as the "deceased person's percentage") of the total underlying interests in the property, a percentage of the total underlying interests in the property equal to the acquired percentage, or the deceased person's percentage at that time, whichever is the less."

Thus, when Mr A's mother acquired an additional percentage of the underlying interests in the Taxpayer's assets on the death of her husband, she was deemed to have held the acquired percentage originally held by Mr A's father at any time Mr A held that percentage.

As Mr A's father held his shares in the Taxpayer from before 20 September 1985, Mr A's mother is similarly deemed to have held these interests from that point of time.

Thus in 19XX there had been no change in the majority underlying ownership of the shares in Company B and the operation of former subsection 160ZZS(1) of the ITAA 1936 would not have applied to deem a new date of acquisition. Therefore subsection 149-10(b) would not apply to the Taxpayer.

    ii.        1997 - Death of Mr A's mother

As this event occurred in 1997, in order to address subsection 149-10(b) we need to consider former subsection 160ZZS(1) of the Income Tax Assessment Act 1936 (ITAA1936). It stated:

For the purposes of the application of this Part in relation to a taxpayer, an asset acquired by the taxpayer on or before 19 September 1985 shall be deemed to have been acquired by the taxpayer after that date unless the Commissioner is satisfied, or considers it reasonable to assume, that, at all times after that date when the asset was held by the taxpayer, majority underlying interests in the asset were held by natural persons who, immediately before 20 September 1985, held majority underlying interests in the asset.

Majority underlying interests was defined in former subsection 160ZZRR(1) of the ITAA 1936 (which was in force from 20 January 1997) to mean in relation to an asset, more than one-half of:

(a)       The beneficial interests that natural persons hold (whether directly or indirectly) in the asset, and

(b)       The beneficial interests held by natural persons (whether directly or indirectly) in any income that may be derived from the asset.

Former subsection 160ZZRU of the ITAA 1936 which replaced subsection 160ZZS(2) with effect from 20 January 1997, and the equivalent provision to subsections 149-30(3) and 149-30(4) of the ITAA 1997), provides:

For the purposes of this Division, if, because of a person's death, a natural person acquires a percentage (the acquired percentage) of the underlying interests in an asset, the natural person is taken to have held (in addition to any other part of the total underlying interests that the person held or is taken to have held), at any time when the dead person held a percentage (the dead person's percentage) of the total underlying interests in the asset, a percentage of the total underlying interests in the asset equal to the acquired percentage, or the dead person's percentage at that time, whichever is the less.

When Mr A's mother passed away in 19XX her three children acquired her previously held interests in the Taxpayer, being the shares she had held since before 20 September 1985 and the shares which she acquired on the death of her husband in 19XX but which she is deemed to have held during the period of his ownership from before 20 September 19XX. The effect of subsection 160ZZRU of the ITAA 1936 is that the three children are deemed to have held the shares during the period that they were owned by their mother which, also includes, by virtue of subsection 160ZZS(2) of the ITAA 1936, the shares which their mother inherited from their father (they are deemed to have held them during the period that they were held by their father).

Consequently, the majority underlying interest in the shares the Taxpayer holds in Company B did not change in 1997 following the death of Mr A's mother and former subsection 160ZZS(1) of the ITAA 1936 would not have applied to deem a new date of acquisition. Therefore subsection 149-10(b) would not apply to the Taxpayer.

   iii.        2001 - Acquisition of Mr E's share

With regard to subsection 149-10(c) it must be determined whether the shares in Company B have stopped being pre-CGT assets because of current Division 149 (introduced from 1 July 1998).

The acquisition of Mr E's shares in the Taxpayer results in a change in an ultimate owner at that time.

In calculating whether there has been change of more than 50% in the underlying interests in the shares, subsection 149-15(1) requires a change in both the beneficial interests in the asset and in any ordinary income derived from the asset.

Before acquiring Mr E's shares Mr A and Ms B together had a majority underlying interest in Company B by virtue of their 66.66% holding in the Taxpayer which they were deemed to have held prior to 20 September 1985. They continued to have the majority underlying interest after the acquisition of Mr E's shares. Therefore the shares in Company B did not stop being a pre-CGT asset of the Taxpayer.

   iv.        2001 - Shares rolled into Holding Companies

In 20XX Mr A and Ms B transferred their interests in the shares of the Taxpayer to their respective holding companies, Company D and Company E. This does not represent a change in the ultimate beneficial owners, as Mr A and Ms B each were the sole shareholders of their holding companies at that time and neither company has a constitution that prevents distributions to members such that the companies themselves would be considered to be ultimate owners.

Mr A and Ms B remained sole shareholders (and accordingly ultimate beneficial owners) of those holding companies throughout the period to XX/YY/20XX.

As such subsection 149-30(1) of the ITAA 1997 has not been triggered as the majority ultimate owners of the Taxpayer, and therefore the majority underlying ownership of the shares in Company B have been maintained for the period 20 September 1985 until XX/YY20XX (immediately prior to the acquisition of Company E by Trust A).

Question 2

Summary

The Commissioner is satisfied that in accordance with subsection 149-30(1) of the ITAA 1997 the acquisition of Company E, the holder of 50% of the shares in the Taxpayer, by Trust A will result in the majority underlying interests held in the pre-CGT assets of the Taxpayer not being maintained such that the pre-CGT assets of the Taxpayer will stop being pre-CGT assets.

Detailed reasoning

Under the factual test in subsection 149-30(1) of the ITAA 1997 an asset stops being a pre-CGT asset at the earliest time when the majority underlying interests in the asset were not held by the ultimate owners who held majority underlying interests in the asset immediately before 20 September 1985.

'Majority underlying interests' is defined in section 149-15 of the ITAA 1997 as more than 50% of:

(a)the beneficial interests that 'ultimate owners' hold (whether directly or indirectly) in the asset; and

(b)the beneficial interests that 'ultimate owners' hold (whether directly or indirectly) in any income that may be derived from the asset.

Subsection 149-15(2) defines an underlying interest in a CGT asset as:

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

An ultimate owner is defined in subsection 149-15(3) to include an individual or a company whose constitution prevents it from making any distribution, whether in money, property or otherwise to its members.

Subsections 149-15(4) and (5) provide that an ultimate owner has an indirect beneficial interest in a CGT asset of another entity if he/she/it would receive for his/her/its own benefit any capital or ordinary income distributed by the entity through interposed entities.

The expression 'beneficial interests' as used in the definition of majority underlying interests is not defined. In general law, where there is a discretionary trust, no beneficiary is entitled to income or capital of the trust until the trustee exercises its discretion to distribute income or to make an appointment of capital. Because a beneficiary holds no interest in any asset of the trust or the ordinary income derived from the asset until the trustee's discretion is exercised, it is inherently impossible for a discretionary trust to satisfy the test set out in subsection 149-30(1). Similarly, it would be equally impossible to trace an indirect underlying interest through a discretionary trust given that a discretionary trust is not itself an "ultimate owner" under subsection 149-15(3).

Assistance is provided in Income Tax Ruling IT 2340 where the terms 'underlying interest' and 'majority underlying interest' as used in section 160ZZS of theITAA 1936 are discussed.

IT 2340 states:

2. The terms "underlying interest" and "majority underlying interests", on the basis of which the provision operates, have the same meanings as they have in Subdivision G of Division 3 of Part III of the Act - which deals with the income tax treatment of interest in relation to "negatively geared" investments in rental property. In both cases (and like provisions of the Act concerned with the measurement of ownership interests) underlying interests in relation to the assets concerned mean beneficial interests held by natural persons, whether directly or through one or more interposed companies, partnerships or trusts. The clear policy of the law thus permits and requires that, for the purposes of the relevant provisions, chains of companies, partnerships and trusts are to be "looked through" in order to determine whether there has been a change in the effective interests of natural persons in the assets [emphasis added].

Paragraph 6 of IT2340 states that in considering the question whether majority underlying interests have been maintained in the assets of a discretionary trust it will be relevant to take into account the way in which the discretionary powers of the trustees are in fact exercised:

6. Where a trustee continues to administer a trust for the benefit of members of a particular family, for example, it will not bring section 160ZZS into application 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.

Company E currently holds a 50% interest in the Taxpayer.

As a result of the transaction executed on XX/YY/20XX, Trust A became the sole shareholder of Company E.

Before the acquisition of the shares in Company E by the Trust A on XX/YY/20XX, the only remaining underlying owners who together had majority underlying ownership of the shares in Company B prior to September 1985 were Mr A and Ms B. After the acquisition of the shares in Company E by Trust A on XX/YY/20XX, the only remaining underlying owner who had an underlying interest in the shares in Company B prior to September 1985 is Mr A and he did not have a majority underlying interest at that time.

After the transaction executed on XX/YY/20XX, Ms B could only be argued to have retained an underlying interest in the shares in Company B if she were a beneficiary of Trust A and would receive distributions from the Trust (IT 2340). This is not the case.

As such, the disposal of Company E to Trust A means that the two individuals who together had a majority underlying interest in the shares in Company B by virtue of their deemed joint control of the Taxpayer from before 20 September 1985 will no longer have joint control following the disposal. Mr A continues to have an underlying interest in Company B but he did not have a majority underlying interest prior to 20 September 1985, his interest at that time being taken to be 33.33%.

Question 3

Summary

The Commissioner is satisfied that in accordance with section 149-35 of the ITAA 1997 the first element of the cost bases of the Taxpayer's assets that stopped being pre-CGT assets upon the change of ownership of Company E will be the market value at the date they ceased being pre-CGT assets.

Detailed reasoning

Division 110 of the ITAA 1997 provides that the cost base and reduced cost base of an asset has five elements. The first element is the money paid for, and the market value of any property given to acquire the asset. The other elements are expenditure in respect of the asset, such as incidental costs of acquisition, and otherwise non-deductible costs of ownership.

Section 149-35 of the ITAA 1997 modifies the general rules in Division 110. It provides that if an asset stops being a pre-CGT asset, the first element of its cost base and reduced cost base is the asset's market value at the time.

On XX/YY/20XX, Trust A acquired the shares in Company E. This change effected a change in the majority underlying interests in the shares in Company B, and they ceased to be a pre-CGT asset at the time Ms B sold her shares in Company E. Under section 149-35 of the ITAA 1997, the Taxpayer is deemed to have acquired the shares in Company B at their market value as at XX/YY/20XX.

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