Edited version of private advice

Authorisation Number: 1051806087979

Date of advice: 19 March 2021

Ruling

Subject: Market value substitution and connected entities

Question 1

What are the capital proceeds for each unit, for the purpose of section 116-20 and section 116-30 of the Income Tax Assessment Act 1997 (ITAA 1997), on the redemption on 1 July 20XX (the Redemption Date) of A class units (the Units) in the Unit trust held by individuals A and B as trustee for the Family Trust?

Answer

Where the market value of each Unit at the Redemption Date is the same as the proceeds, then the capital proceeds for each Unit is the proceeds.

Where the market value of each Unit at the Redemption Date is more or less than the proceeds, the capital proceeds for each Unit is the market value of the Unit.

Question 2

Are each of the following entities connected with the Family trust under section 328-125 of the ITAA 1997?

(a)  Company A

(b)  Each of the individuals A and B

(c)   The Unit Trust

(d)  Company B

Answer

Yes, all of the listed entities are connected for the purpose of section 328-125 of the ITAA 1997.

This ruling applies for the following periods:

Year ending 30 June 20XX

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

Company B is a trading entity specialising in the manufacture and supply of tools.

100% of the shares in Company B are held by Company C in its capacity as trustee for the Unit Trust.

Individuals A and B are both directors of Company C and each owns 50% of the issued ordinary shares.

As at 30 June 20XX, the individuals as Trustee of the Family Trust owned Units in the Unit Trust. These Units had been owned by the Family Trust for more than 12 months as at 30 June 20XX.

The Family Trust was the only holder of "A" class units in the Unit Trust.

The Unit Trust deed states that holders of "A" class units have the right to participate in the distribution of the income of the trust and receive 51% of such income.

The trustee of the Family Trust does not operate a business.

As at 30 June 20XX, fifteen (15) other entities owned ordinary units in the Unit Trust.

Company A, as a beneficiary of the Family Trust, received 100% of the distributions from the Family Trust in each of the 20XX and 20XX income years.

Company A is in the business of plant hire and leasing and is not an exempt entity or deductible gift recipient.[1] Individual A beneficially owns one $1 "A" class share and Individual B beneficially owns one $1 "B" class share in Company A. These two shares are the only shares on issue in Company A.

The constitution of Company A states that the A and B class shares have equal voting rights.

Individuals A and B (together, the Individuals) are residents of Australia for income tax purposes.

On the Redemption Date the Unit Trust redeemed the Units at a redemption price of X per Unit (the Redemption Price).

The Unit Trust Deed includes clauses to the following effect:

•         Unit holders can request that units be redeemed or, if they cease employment with Company B, the unit holders are deemed to request that the units be redeemed.

•         The trustee may within 60 days, if it decides to do so, redeem units subject to the request to redeem.

•         The Redemption Price is X per unit. The trustee and the unit holder can agree to a higher price, but this requires a special resolution (that is a resolution passed by not less than 75% of holders of the issued ordinary units).

Relevant legislative provisions

Income Tax Assessment Act 1997 Paragraph 104-25(1)(a)

Income Tax Assessment Act 1997 Subparagraph 116-30(2)(b)(ii)

Income Tax Assessment Act 1997 Subsection 116-30(2B)

Income Tax Assessment Act 1997 Subsection 116-30(3A)

Income Tax Assessment Act 1997 Section 116-35

Income Tax Assessment Act 1997 Section 328-125.

Income Tax Assessment Act 1997 Paragraph 328-125(2)(a)

Income Tax Assessment Act 1997 Paragraph 328-125(2)(b)

Income Tax Assessment Act 1997 Subsection 328-125(4)

Income Tax Assessment Act 1997 Subparagraph 328-125(4)(a)(i)

Income Tax Assessment Act 1997 Subsection 328-125(5)

Income Tax Assessment Act 1997 Subsection 328-125(7)

Income Tax Assessment Act 1997 Subsection 328-125(8)

Further issues for you to consider

There are a number of clauses in the Unit Trust Deed that may be relevant to working out the market value of each Unit, including (but not limited to) the following:

•         Voting rights of unitholders whilst there exists any A class units.

•         The right of A Class Unit holders to 51% of the income of the Trust

•         Trustee's discretion to issue additional units

•         The transfer of units and the Trustee's discretion to refuse to approve a transfer of units.

•         The Trustee's discretion to dispose of units at such price and on such terms as the Trustee thinks fit.

•         The Trustee's discretion to establish a Reserve out of the Trust Fund before making any payment of net income to unitholders.

•         The Trustee's discretion to transfer any of the investments of the Trust Fund to the trustee of any other trust (whether or not the Trustee is in any way associated with the Trust) upon termination of the Trust.

•         The Trustee's borrowing and lending powers.

•         Guarantee and Indemnities

•         The Trustee's exclusive management rights.

•         The Trustee's remuneration

•         The Trustee's discretion to amend the Deed; and

•         Trustee's discretion to exercise the powers in determining the form and terms of the loan.

You may wish to seek advice from a suitably qualified valuation professional in relation to the market value of the Units as at the Redemption Date.

Reasons for decision

All legislative references are to the ITAA 1997, unless otherwise indicated.

Question 1

Summary

Where the market value of each Unit at the Redemption Date is the same as the Redemption Price, then the capital proceeds for each Unit is the Redemption Price.

Where the market value of each Unit at the Redemption Date is more or less than the Redemption Price, the capital proceeds for each Unit is the market value of the Unit as at the Redemption Date.

Detailed reasoning

Subparagraph 116-30(2)(b)(ii) allows for the capital proceeds from a CGT event to be replaced with the market value of the CGT asset that is the subject of the event if those capital proceeds are more or less than the market value of the asset and the CGT event is CGT event C2 (about cancellation, surrender and similar endings).

CGT event C2 happens if your ownership of an intangible CGT asset ends by the asset being redeemed or cancelled (paragraph 104-25(1)(a)).

Where the CGT asset that is the subject of the event is a unit in a unit trust that has at least 300 unit holders and is not a trust covered by section 116-35, subsection 116-30(2) does not apply to allow the capital proceeds to be replaced with the market value (subsection 116-30(2B)).

All of the Units held by the Family Trust were redeemed on 1 July 20XX. The capital proceeds received by the Family Trust on redemption was X per Unit.

Each Unit is an intangible asset which, upon redemption, triggered CGT event C2.

For the purposes of determining the capital proceeds of each of the Units, consideration must be given to the relevant clauses in the Trust Deed as to whether or not the market value of each of the Units is something other than X.

Clauses in the Trust Deed (see Further Issues for You to Consider, above) are relevant to determining the market value of each Unit.

Where at the Redemption Date, the capital proceeds the Family Trust received for each Unit, is equal to the market value at the Redemption Date of each Unit, the capital proceeds for each Unit will be X.

Where the capital proceeds the Family Trust received on the redemption of each Unit is not equal to the market value, then in accordance with subparagraph 116-30(2)(b)(ii), the capital proceeds received will be replaced with the market value of each Unit as at the Redemption Date.

As at 30 June 20XX, there were a total of 16 Unit holders in the Unit Trust. As the Unit Trust had less than 300 unit holders, subsection 116-30(2B) does not apply to preclude the application of subparagraph 116-30(2)((b)(ii).

Question 2

Summary

Yes, all of the specified entities are connected.

Detailed Reasoning

Under section 328-125, an entity is connected with another entity if:

(a) either entity controls the other entity in a way described in this section; or

(b) both entities are controlled in a way described in this section by the same third entity.

The application of section 328-125 in respect of each of the entities is discussed below.

(a)  Company A

(a)  Under subparagraph 328-125(4)(a)(i), an entity (the first entity) controls a discretionary trust for an income year if, for any of the 4 income years before that year, the trustee of the trust paid to, or applied for the benefit of the first entity any of the income or capital of the trust; and the percentage of the income or capital paid or applied is at least 40% of the total amount of income or capital paid or applied by the trustee for that year.

(b)  An entity does not control a discretionary trust because of subsection 328-125(4) if the entity is an exempt entity or a deductible gift recipient (subsection 328-125(5)).

(c)   As Company A received 100% of the distributions from the Family Trust in each of the 2015 and 2016 income years, being within the 4 years before the current year, and it is neither an exempt entity or a deductible gift recipient, Company A is connected to the Family Trust under subparagraph 328-125(4)(a)(i).

(b)  Individuals A and B

(a)  Under paragraph 328-125(2)(b), an entity (the first entity) controls another entity if the first entity, its affiliates, or the first entity together with its affiliates own, or have the right to acquire the ownership of, equity interests in the company that carry between them the right to exercise, or control the exercise of, a percentage that is at least 40% of the voting power in the company.

(b)  Individual A owns 1 "A" class share and Individual B owns 1 "B" class share in Company A, the only shares in Company A on issue. Company A's company constitution states that "A" and "B" class shares have equal voting rights. As Individual A and Individual B have equal voting rights in Company A, they each hold 50% of the voting rights. As they each hold at least 40% of the voting power in Company A both Individual A and B separately satisfy paragraph 328-125(2)(b). Both Individual A and individual B each separately control, and are therefore each connected with, Company A.

(c)   Under section 328-125(7), where an entity (the first entity) directly controls another entity (the second entity) that first entity is treated as if it also controls any other entity that is directly, or indirectly (by any other application or applications of this section) controlled by the second entity.

(d)  Subsection 328-125(8) provides that subsection 328-125(7) does not apply if the second entity is an entity of any of the following kinds:

-        a company, shares in which (except shares that carry the right to a fixed rate of dividend) are listed for quotation in the official list of an approved stock exchange;

-        publicly traded unit trust;

-        amutual insurance company;

-        amutual affiliate company;

-        a company (other than one covered by paragraph (a)) all the shares in which are owned by one or more of the following:

(a)  a company covered by paragraph (a);

(b)  a publicly traded unit trust;

(c)   a mutual insurance company;

(d)  a mutual affiliate company.

(a)  Company A (the second entity) is not an entity of the kind described in subsection 328-125(8).

(b)  As above, therefore, Company A controls and is therefore connected with the Family Trust under subsection 328-125(4). As both Individuals each control Company A, which in turn controls the Family Trust, Individual A and Individual B are each connected with the Family Trust under subsection 328-125(7).

(c)  The Unit Trust

(a)  Under paragraph 328-125(2)(a), an entity (the first entity) controls another entity if the first entity, its affiliates, or the first entity together with its affiliates except if the other entity is a discretionary trust - own, or have the right to acquire the ownership of, interests in the other entity that carry between them the right to receive a percentage that is at least 40% of any distribution of income by the other entity.

(b)  The Family Trust is entitled to 51% of the income of the Unit Trust.

(c)   As the Family Trust is entitled to receive a percentage that is at least 40% of any distribution from the Unit Trust, the Unit Trust is connected with the Family Trust in accordance with paragraph 328-125(2)(a).

(d)  Company B

(a)  As outlined above, under paragraph 328-125(2)(b), an entity (the first entity) controls another entity if the first entity, its affiliates, or the first entity together with its affiliates own, or have the right to acquire the ownership of, equity interests in the company that carry between them the right to exercise, or control the exercise of, a percentage that is at least 40% of the voting power in the company.

(b)  The Unit Trust holds 100% of the issued shares in Company B. As a 100% shareholder, it owns an equity interest in Company B that carries with it the right to exercise a percentage that is at least 40% of the voting power in the company. In accordance with paragraph 328-125(2)(b) therefore, the Unit Trust controls, and is connected with, Company B.

(c)   Under subsection 328-125(7), where an entity (the first entity) directly controls another entity (the second entity), that first entity is treated as if it also controls any other entity that is directly, or indirectly controlled by the second entity. However, if the second entity is of the kind described in subsection 328-125(8), subsection 328-125(7) does not apply.

(d)  As above, the Family Trust controls the Unit Trust. The Unit Trust (the second entity) is not an entity of the kind described in subsection 328-125(8) to preclude subsection 328-125(7) from applying. As the Unit Trust controls Company B then, in accordance with subsection 328-125(7), the Family Trust also controls Company B. Company B is therefore connected with the Family Trust.

[1] ABN Lookup, Search for Plymouth N.C. Pty Ltd ABN 13 066 267 187 <Retrieved on 9 February 2021>.

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