Edited version of private ruling

Authorisation Number: 1011799993539

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Ruling

Subject: Cost base and market value of shares

Issue 1

Question 1

Is the cost base and reduced cost base of each share in Company B at the relevant time for Company A the market value of the share at that time?

Answer

Yes.

This ruling applies for the following period:

Year ending 30 June 2011

The scheme commences on:

1 July 2010

Issue 2

Question 1

Does the Commissioner accept that the market value of all of the shares held by Company A in Company B at the relevant time is the stated amount?

Answer

Yes.

This ruling applies for the following period:

Year ending 30 June 2011

The scheme commences on:

1 July 2010

Relevant facts and circumstances

Company A is a newly established non-operating holding entity. The only assets held by Company A are the shares in Company B and Company C.

A percentage of shares in Company A were sold by way of an Initial Public Offering (IPO).

On the relevant time, Company A was listed and began trading on the Australian Stock Exchange (ASX).

At the relevant time:

· All of the shares in Company B and Company C were held by Company A.

· Company C had nil net assets.

During the initial period of trading on the ASX, in particular on the first day of trading, a very large volume of Company A shares were traded and the share price of Company A varied significantly from the initial listing price.

Since the relevant time, Company A has not undertaken any significant activities or transactions, nor has Company A become aware of any post-IPO events, facts or circumstances which would have resulted in the variation in its share price.

Company A and its wholly owned subsidiaries will form an income tax consolidated group with effect from the relevant time.

Relevant legislative provisions

Income Tax Assessment Act 1997 Subdivision 705A

Income Tax Assessment Act 1997 Subdivision 705B

Income Tax Assessment Act 1997 section 705-65

Income Tax Assessment Act 1997 subsection 705-65(1)

Does Part IVA apply to this ruling?

Part IVA of the Income Tax Assessment Act 1936 is a general anti-avoidance rule that can apply in certain circumstances if you or another taxpayer obtains a tax benefit in connection with an arrangement and it can be concluded that the arrangement, or any part of it, was entered into or carried out by any person for the dominant purpose of enabling a tax benefit to be obtained. If Part IVA applies the tax benefit can be cancelled, for example, by disallowing a deduction that was otherwise allowable.

We have not fully considered the application of Part IVA to the arrangement you asked us to rule on, or to an associated or wider arrangement of which that arrangement is part.

If you want us to rule on whether Part IVA applies we will first need to obtain and consider all the facts about the arrangement which are relevant to determining whether Part IVA may apply.

For more information on Part IVA, go to our website www.ato.gov.au and enter 'part iva general' in the search box on the top right of the page, then select: Part IVA: the general anti-avoidance rule for income tax.

Reasons for decision

Issue 1 Question 1

Summary

The cost base and reduced cost base of each share in Company B at the relevant time for Company A is the market value of the share at that time.

Issue 2 Question 1

Summary

In accordance with the ATO Guide Market valuation for tax purposes (last modified on 28 May 2010) and on the facts and circumstances, the Commissioner considers it reasonable to accept in this particular case that the market value of a share in Company A at the relevant time can be determined by reference to the closing price of a share in Company A traded on the ASX at that time.

Based on the facts and circumstances, the Commissioner also accepts in this case that the total market value of the shares in Company B at the relevant time is equivalent to the total market value of the shares in Company A at that time.

Detailed reasoning

Company A will form a tax consolidated group with its wholly owned subsidiaries with effect from the relevant time.

Step 1 of ACA calculation

At the formation time for a consolidated group, the head company of the group works out the ACA for each entity (joining entity) that becomes a subsidiary member of the group. The ACA is then allocated to the assets of the joining entity to align the cost of acquiring the joining entity with the cost of the assets of the joining entity.

Subdivision 705-A of the ITAA 1997 contains the general rules setting out how the cost is allocated where an entity joins a consolidated group. Section 705-140 of the ITAA 1997 ensures that the rules in Subdivision 705-A have effect in the case of group formation, subject to the modifications set out in Subdivision 705-B of the ITAA 1997.

Step 1 in working out the ACA for a joining entity is about working out the cost of membership interests in the joining entity held by members of the joined consolidated group. Section 705-65 of the ITAA 1997 contains the rules to work out the step 1 amount.

Subsection 705-65(1) of the ITAA 1997 states:

For the purposes of step 1 in the table in section 705-60, the step 1 amount is the sum of the following amounts for each *membership interest that *members of the joined group hold in the joining entity at the joining time:

Working out the step 1 amount
Item	If the market value of the membership interest is...	The amount is...
1	equal to or greater than its*cost base	its cost base
2	less than its *cost base but greater than its *reduced cost base	its *market value
3	less than or equal to its*reduced cost base	its reduced cost base

An ordinary share in a company would generally qualify as a membership interest (as defined in section 960-135 of the ITAA 1997).

As determined in issue 1 above, the cost base and reduced cost base of each share in Company B at the relevant time for Company A is the market value of the share at that time. Accordingly, in respect of Company B becoming a member of the Company A tax consolidated group, the Step 1 amount of the ACA calculation is the sum of the cost base or reduced cost base of each membership interest that Company A holds in Company B, and it effectively equals the sum of the market value of each share held by Company A in Company B at the relevant time.

Market value of the shares in Company A

Although the law frequently refers to market value, the meaning of that term will depend on its statutory context. In each instance you need to take into account the context in which the term is used, and pay particular attention to its definition and any specific requirements in that context. Where a statutory definition is provided for a particular context, it must be used.

The ATO guide Market valuation for tax purposes provides general guidance on the ATO's expectations in relation to valuations for tax purposes and the ordinary meaning of market value. It also outlines methods generally used to determine market value of assets and states:

To determine the market value, you should use the most appropriate valuation method. Where comparable arm's length sales data is available (for example, in a market for a commodity product), this is generally considered the most appropriate method.

Where a market exists for an asset, that market is widely considered to be the best evidence of market value of the asset.

In respect of valuing listed shares, the ATO guide Market valuation for tax purposes states:

As listed ordinary shares are commonly traded on a daily basis, you may be able to rely on the appropriate share market as the source for valuing a listed ordinary share.

…

Where a stock is relatively liquid and does not exhibit significant price volatility, you may, in certain circumstances, refer to a point-in-time valuation (such as the closing price of a share). …

A common method of smoothing the effects of illiquidity (that is, thin trading) and volatility of a stock is for a person to adopt the volume weighted average price (VWAP) of the stock over a certain period. You may also adopt the VWAP method if the stock is liquid but does not exhibit excessive volatility. Within a tax context, this method is commonly applied to corporate events and actions.

Furthermore, the Appendix to the ATO guide Market valuation for tax purposes at Table 2 titled 'Products and methodologies based on asset class' states that trading benchmarks (e.g. VWAP/closing price) is a commonly adopted method for equity in the tax context of cost base setting and entries into consolidated group.

Based on the facts and information provided, the Commissioner considers it reasonable to accept in this particular case that the market value of a share in Company A at the relevant time can be determined by reference to the closing price of the shares in Company A traded on the ASX on that day. It follows that the total market value of the shares in Company A at the relevant time was the stated amount (calculated as the closing price of a share on that day multiplied by the total number of shares on issue).

Market value of the shares in Company B

As at the relevant time, the only assets held by Company A were all of the issued shares in Company B and all of the issued shares in Company C. As Company C effectively had nil net assets at the relevant time, it is accepted that Company C is allocated a zero value for the purpose of determining the market value of the shares in Company B. On this basis, the Commissioner considers it reasonable to accept in this particular case that the total market value of the shares in Company B at the relevant time is equivalent to the total market value of the shares in Company A at that time.

Accordingly, the Commissioner considers it reasonable to accept that the market value of a share in Company B at the relevant time will be approximately the stated amount per share (i.e. the total market value of the shares in Company B divided by the total number of shares in Company B).