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Ruling

Subject: Redemption of units

Question

Will the capital proceeds from the redemption of the units be the redemption amount if this amount is less than the market value of the units?

Answer

No.

This ruling applies for the following periods:

Year ended 30 June 2012

Year ended 30 June 2013

Year ended 30 June 2014

Year ended 30 June 2015

The scheme commences on:

1 July 2011

Relevant facts and circumstances

You are a trust.

Your trustee director and beneficiary (individual) is proposing to join a newly set up business.

The business is set up as a unit trust which will have a small number of unit holders (less than 300).

A contract is to be signed and units in the unit trust are to be issued in exchange for payment of an amount, which is the cost base of the units.

The units in the unit trust are to be acquired by you.

The contract states that when the individual leaves, the units must be redeemed by the unit trust at the redemption amount equal to the initial payment on the signing of the contract and not the market value at the time, even though the business profit is expected to increase considerably, resulting in an expected increase in the market value of the units.

The units will be cancelled following the redemption.

Your units would only provide distributions of income and not distributions of capital gains.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 104-25

Income Tax Assessment Act 1997 Section 108-5

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

Income Tax Assessment Act 1997 Section 116-30

Income Tax Assessment Act 1997 Section 116-35

Does Part IVA apply to this ruling?

Part IVA of the Income Tax Assessment Act 1936 (ITAA 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 of the ITAA 1936 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 of the ITAA 1936 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

CGT event C2 under section 104-25 of the Income Tax Assessment Act 1997 (ITAA 1997) happens if ownership of an intangible CGT asset ends by the asset:

(a) being redeemed or cancelled

(b) being released, discharged or satisfied

(c) expiring or

(d) being abandoned, surrendered or forfeited.

A unit in a unit trust is a CGT asset under section 108-5 of the ITAA 1997. CGT event C2 happens when units in a unit trust are redeemed by the trustee as any proprietary or equitable interest conferred by the units are extinguished at the time of redemption, thereby effectively extinguishing the units.

A capital gain will be made if the capital proceeds from the ending are more than the cost base of the units, and a capital loss will be made if those capital proceeds are less than the reduced cost base of the units.

Subsection 116-20(1) of the ITAA 1997 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).

The market value substitution rule in subparagraph 116-30(2)(b)(ii) of the ITAA 1997 provides, however, that if there are capital proceeds from a CGT event, the capital proceeds are 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. The market value in this case is worked out as if the event had not occurred and was never proposed to occur (subsection 116-30(3A) of the ITAA 1997).

Subsection 116-30(2B) of the ITAA 1997 provides, however, that subsection 116-30(2) of the ITAA 1997 does not apply where the CGT asset that is the subject of CGT event C2 is a unit in a unit trust that has at least 300 unit holders and is not a trust that is covered by section 116-35 of the ITAA 1997.

Applying the above to your circumstances

CGT event C2 under section 104-25 of the ITAA 1997 will happen if your units are redeemed as your units will be cancelled following the redemption. The market value substitution rule in subparagraph 116-30(2)(b)(ii) of the ITAA 1997 will therefore apply to replace the capital proceeds with the market value of the units, as the market value of the units is expected to be more than the capital proceeds received as a result of the redemption. Subsection 116-30(2B) of the ITAA 1997 will not apply as the unit trust will not have at least 300 unit holders.

The cost base of your units in this case is equal to the redemption amount of the units. This means that if the market value of your units at the time that they are redeemed is more than the redemption amount, you will make a capital gain as a result of the redemption.