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Ruling
Subject: Direct Value Shifting Rules
Question 1
Will the subscription by Company A pursuant to a rights issue to 99.99% of the share value of Company B for a nominal value, give rise to a direct value shift by Company C within the meaning of section 725-145 of the Income Tax Assessment Act 1997 (ITAA 1997)?
Answer
No
Question 2
If question 1 is answered in the affirmative, will the proposed restructure give rise to a taxing event for Company C under section 725-245 of the ITAA 1997?
Answer
Not Applicable
Relevant facts and circumstances
Company B is a non-resident .' Company C, an Australian resident holds a minority interest in Company B's shares. The non-resident shareholders want to raise capital for Company B's operations by conducting a proposed restructure. Company C is not an associate of the non-resident shareholders for the purposes of section 318 of the Income Tax Assessment Act 1936.
Details of the proposed restructure are as follows:
Company A will be incorporated as a non-resident company. Its shares will initially be held by all shareholders in the same proportions as they hold Company B.
Company B will make an offer for a rights issue to the other shareholders to subscribe for additional Company B shares. Company C and the other existing shareholders will waive their rights and Company A will instead exercise the rights and pay subscription money to Company B.
Company C intends to vote against the restructure but even if it does so the other existing shareholders have sufficient voting power for the restructure to proceed. Company C has no power of veto in respect of the proposed restructure.
Shares held by Company C in Company B are post capital gains tax (CGT) assets.
Relevant legislative provisions
Income Tax Assessment Act 1997
section 725-50
section 725-55
subsection 725-65(2)
section 725-80
section 725-145
subsection 725-155(1)
section 725-245
Income Tax Assessment Act 1936
section 318
Reasons for decision
A direct value shift only has consequences under Division 725 of the ITAA 1997 if the conditions in section 725-50 are satisfied, including:
(d) You are an *affected owner of a *down interest, or an *affected owner of an *up interest, or both;
Company C's shares in Company B constitute down interests in the target entity Company B under subsection 725-155(1) of the ITAA 1997 as their market value will decrease because of the issue, at a significant discount, of Company B shares to Company A under the proposed restructure.
To constitute an affected owner of down interests under section 725-80 of the ITAA 1997 Company C must be an active participant in the scheme under paragraph (c). This is because Company C is neither the controller of Company B for the purposes of subsection 725-55 of the ITAA 1997, nor an associate of the controller.
*Active participant is defined under subsection 725-65(2) of the ITAA 1997:
An entity (the first entity) is an active participant in the *scheme if, and only if:
(a) at some time during the *scheme period, the target entity has fewer than 300 members (in the case of a company) or fewer than 300 beneficiaries (in the case of a trust); and
(b) the first entity has actively participated in, or directly facilitated, the entering into or carrying out of the *scheme (whether or not it did so at the direction of some other entity); and
(c) the first entity:
(i) owns a *down interest at the *decrease time; or
(ii) owns an *up interest at the *increase time or has an up interest issued to it at a *discount because of the *direct value shift.
The target entity, Company B, has fewer than 300 members.
'The Guide' to the General Value Shifting Regime, provides guidance on the meaning of the term active participant.
Relevantly, section 6.5.1 of the Guide provides:
'an entity is an active participant in a scheme if they participated in, or directly facilitated, the entering into or carrying out of the scheme. In both cases, some degree of knowledge of the scheme is required. Active participation requires something more than simply receiving the benefits from the scheme and may involve doing something that is capable of exerting influence over the scheme'.
The notion of 'exerting influence' over a scheme is highlighted in Example 6-8 of the Guide. In the example the support of either shareholder, in the form of voting for the proposed value shift, is critical to its implementation. Hence their support for the proposal will amount to active participation.
In voting against the restructure it cannot be said that Company C will be doing anything more than simply receiving the benefits of the scheme that it did not want and whose influence will be insufficient to stop it occurring.