Edited version of private advice

Authorisation Number: 1051875799839

Date of advice: 28 July 2021

Ruling

Subject: Proposed sale of shares and capital gains tax

Question

Is Individuals X & Y's capital gain under CGT event C2 in section 104-25 of the ITAA 1997 from the cancellation of its share rights in the Company disregarded under section 855-10?

Answer

Not applicable

This ruling applies for the following period:

Income year ended 30 June 20XX

The scheme commences on:

During the income year ended 30 June 20XX

Relevant facts and circumstances

The Company is a trading entity and 100% of the shares in the Company was held by the Owner since incorporation.

The Company does not own any land or real property.

Contract for sale of shares

Individuals X & Y reside overseas and are a non-resident for Australian tax purposes.

A contract for the sale of 20% of the shares in the Company was entered into between the Owner and Individuals X & Y in 20XX.

The terms of the contract are contained in informal emails exchanged between the two.

The terms of the contract included a purchase consideration of $X.

The purchase consideration was paid, in full, prior to June 20XX.

A formal 'shareholders agreement' as described in the offer in Individuals X's email was not done as both parties considered the agreement was made.

Share transfer forms have not been completed and Individuals X & Y have not been registered as shareholders of the Company.

Individuals X & Y has never received any dividends from the Company and have not obtained a directorship in the Company.

The Owner has not advised ASIC of any change to the beneficial ownership of the shares in the Company.

Proposed Sale of the Company

The Owner is looking to sell the Company and is currently looking for buyers.

The taxpayer's representative has advised that the agreement for Individuals X & Y to acquire 20% of the shares in the Company could potentially have a negative impact on the sale price when its existence becomes known to a purchaser.

The taxpayer's representative has advised that the Owner is currently considering three options:

(a)  Having the purchaser acquire/cancel Individuals X & Y's rights directly so that they receive 20% of the net sale proceeds for cancelling the rights and the Owner receives 80% of the net sale proceeds for selling the shares.

(b)  Having the Owner sell 20% of the shares to Individuals X & Y shortly before the sale (for the zero exercise price) so that that Individuals X & Y receive 20% of the net sale proceeds for selling their shares and the Owner receives 80% of the net sale proceeds for selling its shares.

(c)  Having Individuals X & Y agree to cancel the rights (to acquire 20% of the shares) against the Owner in consideration for an amount calculated with reference to 20% of the net sale proceeds.

The taxpayer's representative has advised that all three options would have the same economic consequences as they would each:

• Make the shares a more attractive purchase prospect thereby resulting in a maximised/increased sale price (i.e. each option would maintain and protect the true intrinsic value of the shares and they could each enhance that value); and
• Result in a 20/80 split in the net sale proceeds between Individuals X & Y and the Owner.

The taxpayer's representative has requested that the Commissioner consider Option (c) (i.e. cancellation of Individuals X & Y's rights).

The taxpayer's representative has advised that under Option (c), the Owner's payment to Individuals X & Y would be funded by the Owner selling 100% of the shares in the Company and using 20% of the net proceeds to discharge the Owner's indebtedness to Individuals X & Y.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 102-20

Income Tax Assessment Act 1997 section 104-10

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

Income Tax Assessment Act 1997 subsection 110-25(5)

Income Tax Assessment Act 1997 Division 855

Income Tax Assessment Act 1997 section 855-10

Income Tax Assessment Act 1997 section 855-15

Income Tax Assessment Act 1997 section 855-20

Income Tax Assessment Act 1997 subsection 855-25(1)

Income Tax Assessment Act 1997 section 855-30

Income Tax Assessment Act 1997 section 960-195

Reasons for decision

Summary

Individuals X & Y are the beneficial owner of 20% of the shares in the Company. Therefore, there are no 'share rights' to be cancelled and CGT event C2 will not occur.

Any capital gain pursuant to CGT Event A1 made by Individuals X & Y for the proposed sale of their beneficially owned shares in the Company will be disregarded in accordance with section 855-10 of the ITAA 1997.

Detailed reasoning

CGT event A1 of the ITAA 1997 happens if you dispose of a CGT asset to someone else (section 104-10).

A change in the ownership of a CGT asset does not occur if the taxpayer stops being the legal owner of the CGT asset but continues to be its beneficial owner (subsection 104-10(2) of the ITAA 1997).

CGT event A1 of the ITAA 1997 happens if there is a change in beneficial ownership and not legal ownership (Ellison & Anor v Sandini Pty Ltd & Ors; FC of T v Sandini Pty Ltd & Ors - Media neutral citation: [2018] FCAFC 44 (Sandini)).

The ATO's Decision Impact Statement on Sandini states the following in relation to the effect of that case upon the application of the decision in that case to a change in ownership:

CGT event A1 in section 104-10 of the ITAA 1997 is triggered by a change of ownership of a CGT asset. The type of change that is relevant will depend on the type of ownership the holder of the CGT asset has and what the purported acquirer obtains and whether, for example, their ownership is recognised at law or in equity. Most transactions give rise to clear changes in ownership without needing to address considerations that arise because ownership has been divided.

It is clear that CGT event A1 in section 104-10 of the ITAA 1997 does not happen if:

• there is a mere change in the trustee of a trust (as subsection 960-100(2) of the ITAA 1997 provides that the trustee of a trust is taken to be an entity consisting of the person who is the trustee at any given time)

• a person transfers legal ownership but continues to be the beneficial owner (an exception in CGT event A1 itself).

Consistent with the decision of the majority of the Full Court, we consider that triggering CGT event A1 in section 104-10 of the ITAA 1997 does not require a change in legal as well as beneficial ownership.

Further, we consider that a change in beneficial ownership does not occur unless the purported acquirer of the CGT asset has full dominion over it that a court of equity would enforce. This is akin to the rights to specific performance a purchaser of land obtains upon paying the settlement sum. It is not sufficient for a change in beneficial ownership that the purported acquirer of the CGT asset has some form of proprietary interest, or equitable or beneficial interest in the asset falling short of beneficial ownership, and the purported seller has retained rights to deal with the asset, including powers of disposition over it.

A person may beneficially own a share without being a shareholder, such as where the share is owned by a nominee: see J Sainsbury plc v O'Connor (Inspector of Taxes) [1991] STC 318 and KLDE Pty Ltd v Commissioner of Stamp Duties (Qld) (1984) 155 CLR 288; 15 ATR 1214.

In relation to a change in beneficial ownership under a share sale contract the relevant case law provides that beneficial ownership vests in the purchaser upon payment of the full purchase consideration to the vendor.

R v. Australian Broadcasting Tribunal; Ex parte Hardiman (1980) 144 C.L.R. 13 (at p. 31 per Gibbs, Stephen, Mason, Aickin and Wilson JJ) it was stated that:

"a purchaser who can by way of specific performance compel a transfer of shares under a contract is a beneficial owner of the shares.''

In KLDE Pty Ltd v Commissioner of Stamp Duties [1984] QSCFC 1 Macrossan J (at 4132) stated that:

In a more general context, sometimes one sees a distinction drawn between cases where the purchaser under a contract has or has not paid the purchase money and sometimes there is reserved for the former case the statement that the purchaser has become entitled in equity to the property and the vendor has become a bare trustee: McWilliam v. McWilliams Wines Pty. Limited (1964) 114 C.L.R. 656 per McTiernan and Taylor JJ. at p. 660 and cf. the similar statement made in passing by Lord Somervell in Escoigne Properties Ltd. v. I.R. Commrs. (supra) at p. 563.

Sometimes the principle is stated without reference to that distinction as in Lysaght v. Edwards (1876) 2 Ch.D. 499 at p. 506 where, in the judgment of Jessell M.R., it is said that: "the moment you have a valid contract for sale the vendor becomes in equity a trustee for the purchaser of the estate sold, and the beneficial ownership passes to the purchaser, the vendor having a right to the purchase money, etc.''.

Nevertheless it seems clear that the existence of any equitable interest in a purchaser depends upon the availability to him of equitable remedies in general and the equitable remedy of specific performance in particular: Central Trust and Safe Deposit C.O. v. Snider (1916) 1 A.C. 266 at p. 272 ; Brown v. Heffer (1967) 116 C.L.R. 344 at p. 349 ; and Legione v. Hateley (1983) 57 A.L.J.R. 292 at p. 308 .

When after a contract for the sale of land it is said that the vendor is a trustee for the purchaser "it is tacitly assumed that the contract would in a Court of equity be enforced specifically'': Central Trust and Safe Deposit C.O. v. Snider (supra) at p. 272.

In KLDE Pty Ltd v Commissioner of Stamp Duties (Qld) [ 1984 ] HCA 63; (1984) 155 CLR 288 at 296 (KLDE) the High Court noted that:

Where the contract is capable of being specifically performed the vendor, pending payment of the balance of purchase price, is not a bare trustee (he has been described as a trustee sub modo : see Chang v Registrar of Titles (1976) 8 ALR 285 at 291; 137 CLR 177 at 184 - 5). However, so far as the interest of the purchaser is concerned, this court was clearly of the view in R v Australian Broadcasting Tribunal; Ex parte Hardiman (1980) 29 ALR 289 ; 144 CLR 13 that: "a purchaser who can by way of specific performance compel a transfer of shares under a contract is a beneficial owner of the shares " : (ALR) at p 302; (CLR) at p 31, per Gibbs, Stephen, Mason, Aickin and Wilson JJ.

In relation to the contract for sale of shares between the Owner and Individuals X & Y the full consideration for the purchase of the shares was paid sometime before June 20XX. As such, Individuals X & Y were able to compel the transfer of 20% of the shares in the Company from the Owner and became the beneficial owners of these shares.

Any further proposed dealing, or transaction, in relation to the 20% of the shares beneficially owned by Individuals X & Y bears no relevance to the cost base of the 80% of the Company shares that are legally and beneficially owned by the Owner.

Capital gains tax

Under section 102-20 of the ITAA 1997 you make a capital gain or capital loss as a result of a CGT event.

You make a capital gain if the capital proceeds from the ending are more than the asset's cost base. You make a capital loss if those capital proceeds are less than the asset's reduced cost base.

In this case, CGT event A1 will occur if Individuals X & Y's beneficially owned shares in the Company are sold.

Capital gains tax for non-residents

A non-resident can only make a capital gain or loss if a CGT event happens to an asset that is taxable Australian property. The term 'taxable Australian property' is defined in the table in section 855-15 of the ITAA 1997 and covers five categories of assets.

Broadly, these categories are:

1) taxable Australian real property

2) an indirect interest in Australian real property

3) a business asset of a business with a permanent establishment in Australia

4) options or rights to acquire a CGT asset in items 1, 2 or 3

5) CGT assets covered by subsection 104-165(3) of the ITAA 1997 (choosing to disregard a capital gain or capital loss on ceasing to be an Australian resident).

Taxable Australian Property

The rules in Division 855 of the ITAA 1997 ensure that interests in an entity remain subject to Australia's CGT laws if the entity's underlying value is principally derived from Australian real property.

Subsection 855-10(1) of the ITAA 1997 provides as follows:

Disregard a capital gain or capital loss from a CGT event if:

(a) you are a foreign resident, or the trustee of a foreign trust for CGT purposes, just before the CGT event happens; and

(b) the CGT event happens in relation to a CGT asset that is not taxable Australian property.

Section 855-15 of the ITAA 1997 sets out 5 categories of CGT assets that are taxable Australian property.

Section 855-20 of the ITAA 1997 defines taxable Australian real property (TARP) as follows:

A CGT asset is TARPif it is:

(a) real property situated in Australia (including a lease of land, if the land is situated in Australia); or

(b) a mining, quarrying or prospecting right (to the extent that the right is not real property), if the minerals, petroleum or quarry materials are situated in Australia.

In this case, the only items which would potentially apply to the sale of Individuals X & Y's shares in the Company would be item 2.

Item 1 involves a direct investment in Australian real estate. Item 3 involves the sale of Australian branch assets. Item 4 is an option or right to acquire a CGT asset which is covered by items 1, 2 or 3 of this table. Item 5 deals with Australian residents who have migrated and set up operations offshore. Item 5 is not relevant due to the residency status of Individuals X & Y.

Item 2 - Indirect Australian Real Property Interest

An indirect Australian real property interest is defined in section 855-25 of the ITAA 1997 and subsection 855-25(1) states that a membership interest held by an entity (the holding entity) in another entity (the test entity) at a time is an indirect Australian real property interest at that time if:

(a) the interest passes the non-portfolio interest test (see section 960-195):

(i) at that time; or

(ii) throughout a 12 month period that began no earlier than 24 months before that time and ended no later than that time; and

(b) the interest passes the principal asset test in section 855-30 at that time.

For the purposes of subsection 855-25(1) of this ITAA 1997, in this case the 'test entity' is the Company.

The non-portfolio interest test in section 960-195 of the ITAA 1997 requires a person (together with their associates) to (directly) own at least 10% of the Australian company.

The principal asset test is defined in section 855-30 of the ITAA 1997 to essentially mean where more than 50% of the value of the sale entity's assets is attributable (directly or indirectly) to TARP in Australia. As explained above, TARP is defined in section 855-20 to be "real property situated in Australia (including a lease of land, if the land is situated in Australia) ...". At common law, the ordinary meaning of "real property" is an interest in land equivalent to a freehold interest.

Because the Company does not have any Australian land or real property and the bulk of its value is inherent goodwill, it would not pass the principal asset test and hence item 2 of section 855-15 of the ITAA 1997 would not apply in this case.

Individuals X & Y are both a foreign resident just before the proposed CGT event happens and the CGT event will happen in relation to shares in the Company that are not taxable Australian property.

Therefore, Individuals X & Y may disregard any capital gain made pursuant to CGT Event A1 made by Individuals X & Y for the proposed sale of its beneficially owned shares in the Company under section 855-10 of the ITAA 1997.

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