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Advice

Subject: Pre-CGT status of the goodwill of the business of the taxpayer

Question 1

Does the Commissioner extend the time allowed under subsection 149-55(1) of the Income Tax Assessment Act 1997 (ITAA 1997) to give written evidence about majority underlying interests in the goodwill of the taxpayer at the end of each test day?

Advice

For the purpose of subsection 149-55(1) of the ITAA 1997, the Commissioner has extended the time to provide written evidence to the Commissioner about the majority underlying interests in the taxpayer until 31 October 2011.

Question 2

Is the Commissioner satisfied that, at the end of the test day, majority underlying interests in the taxpayer's goodwill were held by ultimate owners who also had majority underlying interest in the goodwill as at 19 September 1985?

Advice

Yes

This advice applies for the following periods:

Year ended 30 June 2011

Year ending 30 June 2012

The arrangement commences on:

1 January 2011

Relevant facts and circumstances

The business commenced by the taxpayer prior to September 1985 continues today.

The original capital of the taxpayer was divided into two classes of shares. Additional shares in each class were issued to new shareholders (controlling shareholders) prior to 1985.

As at 19 September 1985, the issued shares in the taxpayer were held by the controlling shareholders (over 50%) and other parties (the remaining shares).

After 1985, the taxpayer issued additional shares to the controlling shareholders for a nominal amount and the minority shares owned by other parties were bought back.

All issued shares in both classes were converted without consideration into a single class of ordinary shares and split.

A number of shares were then issued to new investors and the taxpayer was subsequently listed on the Australian Securities Exchange (ASX).

Subsequently, one of the controlling shareholders transferred certain shares to another controlling shareholder.

A few months later, the taxpayer again issued a small number of new shares for the second time.

The shares in the taxpayer held by the controlling shareholders were not to be transferred to a third party, at any time from when the taxpayer was listed on the ASX.

The only pre-CGT asset owned by the taxpayer is the goodwill of its business.

Relevant legislative provisions

Income Tax Assessment Act 1997 Division 149

Income Tax Assessment Act 1997 Subdivision 149-B

Income Tax Assessment Act 1997 Section 149-15

Income Tax Assessment Act 1997 Subsection 149-15(1)

Income Tax Assessment Act 1997 Subsection 149-15(2)

Income Tax Assessment Act 1997 Subsection 149-15(3)

Income Tax Assessment Act 1997 Subsection 149-25

Income Tax Assessment Act 1997 Section 149-30

Income Tax Assessment Act 1997 Subsection 149-30(1)

Income Tax Assessment Act 1997 Subsection 149-30(2,

Income Tax Assessment Act 1997 Subdivision 149-C

Income Tax Assessment Act 1997 Section 149-50

Income Tax Assessment Act 1997 Subsection 149-50(1)

Income Tax Assessment Act 1997 Paragraph 149-50(1)(a)

Income Tax Assessment Act 1997 Section 149-55

Income Tax Assessment Act 1997 Subsection 149-55(1)

Income Tax Assessment Act 1997 Subsection 149-55(1)(a)

Income Tax Assessment Act 1997 Subsection 149-55(1)(b)

Income Tax Assessment Act 1997 Subsection 149-55(1B)

Income Tax Assessment Act 1997 Subsection 149-55(2)

Income Tax Assessment Act 1997 Subsection 149-55(5)

Income Tax Assessment Act 1997 Subsection 149-55(6)

Income Tax Assessment Act 1997 Section 149-60

Income Tax Assessment Act 1997 Subsection 149-60(1)

Income Tax Assessment Act 1997 Section 149-70

Income Tax Assessment Act 1997 Subdivision 960-H

Income Tax Assessment Act 1997 Section 960-220

Income Tax Assessment Act 1997 Section 960-225

Income Tax Assessment Act 1997 Subsection 960-225(1)

Income Tax Assessment Act 1997 Subsection 960-225(2)

Income Tax Assessment Act 1997 Subsection 960-230

Income Tax Assessment Act 1997 Subsection 995-1

Reasons for decision

Question 1

Subsection 149-55(1) of the ITAA 1997 requires a public entity to give to the Commissioner within 6 months after each test day written evidence about majority underlying interests in an asset at the end of each test day.

Further information was supplied more than 6 months after the test day; therefore the Commissioner must consider whether an extension of time to provide written information about majority underlying interests should be granted.

Paragraphs 74 to 79 of Taxation Ruling TR 2004/7 Income tax: capital gains: application of Division 149 of the Income Tax Assessment Act 1997 and Division 20 of Part IIIA of the Income Tax Assessment Act 1936 to public entities provides guidelines as to when an extension of time should be granted to provide evidence about majority underlying interests.

The Commissioner has, having regard to the taxpayer's circumstances, exercised his discretion under subsection 149-55(1) of the ITAA 1997 to allow further time to provide written evidence about the majority underlying interests in the goodwill of the business.

Question 2

Division 149 of the ITAA 1997 makes provision for when a CGT asset of an entity stops being a pre-CGT asset.

After the taxpayer was listed on the ASX, it became subject to Subdivision 149-C. Subdivision 149-C does not apply to the CGT assets of a non-public entity (which is covered by Subdivision 149-B of the ITAA 1997).

Subdivision 149-B

The transaction under which new shares were issued by the taxpayer before the taxpayer became a public company is therefore, covered by Subdivision 149-B of the ITAA 1997.

Subsection 149-30(1) of the ITAA 1997 applies to the CGT assets of a non-public company. The assets stop being a pre-CGT asset when majority underlying interests in the asset were not had by ultimate owners who had majority underlying interests in the asset immediately before 20 September 1985.

Majority underlying interests in a CGT asset are defined in subsection 149-15(1) of the ITAA 1997 as consisting of:

(a) more than 50% of the beneficial interests that ultimate owners have in the asset, and

(b) more than 50% of beneficial interests that ultimate owners have in the ordinary income that may be derived from the asset.

An underlying interest is defined in subsection 149-15(2) of the ITAA 1997 as the beneficial interest that an ultimate owner has directly or indirectly in the asset or any ordinary income that may be derived from that asset.

An ultimate owner is relevantly defined in subsection 149-15(3) of the ITAA 1997 as including an individual. The controlling shareholders are individuals.

The controlling shareholders in the taxpayer together owned more than 50% of the issued shares in the taxpayer throughout the relevant period prior to listing on the ASX. Accordingly, the Commissioner can be satisfied under subsection 149-30(2) of the ITAA 1997 that, at all relevant times, the majority underlying interests in the goodwill of the taxpayer were had by ultimate owners who had majority underlying interests on and after 20 September 1985.

Subdivision 149-C

Subdivision 149-C of the ITAA 1997 applies to the pre-CGT assets of a company whose shares are listed for quotation in the official list of an approved stock exchange (paragraph 149-50(1)(a) of the ITAA 1997).

Section 149-70 in the ITAA 1997 states that an asset stops being a pre-CGT asset if the condition in subsection 149-60(1) is not satisfied.

Subsection 149-60(1) of the ITAA 1997 states that:

on the basis solely of the evidence given to the Commissioner under subsection 149-55(1), the Commissioner must be satisfied that, or think it reasonable to assume that, at the end of the *test day, *majority underlying interests in the asset were had by *ultimate owners who also had *majority underlying interests at the end of the starting day.

As the taxpayer has not chosen otherwise the starting day is 19 September 1985.

Subsection 149-55(1) of the ITAA 1997 requires an entity to give to the Commissioner written evidence about majority underlying interests in an asset at the end of each test day. This evidence must be provided within 6 months after each test day (the Commissioner may extend the period for doing so).

Subsection 149-55(1B) of the ITAA 1997 provides that the only consequence of failing to give evidence is set out in section 149-70 (i.e. the asset stops being a pre-CGT asset). The only asset owned by the taxpayer on 19 September 1985, and still owned by the taxpayer in 2011 is the goodwill of the business conducted by the taxpayer.

Test day

A test day is defined in subsection 149-55(2) of the ITAA 1997 as including:

(aa) 30 June 1999,

(a) a day that is 5 years (or a multiple of 5 years) after 30 June 1999;

(b) if the entity is covered by paragraph 149-50(1)(a) or (e) - a day on which there is *abnormal trading in *shares in the company;

As discussed above from the date of listing the taxpayer is covered by paragraph 149-50(1)(a) of the ITAA 1997. As a result, a test day will occur on each day that is a five year multiple of 30 June 1999, i.e. on 30 June 2014, and on each day on which there is abnormal trading in the shares of the taxpayer.

Paragraph 149-55(2)(b) of the ITAA 1997 defines a test day as including a day on which there is abnormal trading in shares in the company. Section 995-1 of the ITAA 1997 states that abnormal trading has the meaning given in Subdivision 960-H of the ITAA 1997.

Abnormal trading

Subsection 960-225(1) of Subdivision 960-H of the ITAA 1997 relevantly provides that there is abnormal trading if trading in the shares of a company is abnormal, having regard to all relevant factors including these:

o the timing of the trading, when compared with the normal timing for trading in the company's shares;

o the number of shares traded, when compared with the normal number of the company's shares traded;

o any connection between the trading and any other trading in the company's shares; and

o any connection between the trading and a tax loss or other deduction of the company.

Subsection 960-225(1) of the ITAA 1997 applies tests comparing the actual trade in shares under consideration and the normal trade in shares. Subsection 960-225(1) also requires all of the listed factors to be considered to determine if there has been abnormal trading. Where one factor applies and other factors do not apply to offset that factor, that single factor may be the only relevant factor to be considered. Paragraph 960-225(1)(b) is the only relevant factor to be considered.

Section 960-230 of the ITAA 1997 also provides that there is abnormal trading in the shares of a company if 5% or more of the shares in a company are traded in one transaction.

The operation of Subdivision 960-H of the ITAA 1997 is changed by subsection 149-55(5) of the ITAA 1997 for the purposes of the determining what is abnormal trading for the operation of section 149-55. Subsections 149-55(6) of the ITAA 1997 provides that an issue, redemption or transfer, or any other dealing, is a trading if, and only if, it changes the respective proportions in which ultimate owners have underlying interests in the CGT assets of the company.

The first transfer of shares

One of the controlling shareholders transferred a significant number of shares to another controlling shareholder. The evidence provided to the Commissioner indicates that the shares owned by the controlling shareholders were not available for transfer to third parties during the relevant period. This means that the maximum number of shares actually available for trade on the ASX on any day was the number of shares independently owned by parties other than the controlling shareholders.

The transfer of shares between the controlling shareholders constitutes a share trade for the purposes of section 960-220 of the ITAA 1997. Subsection 149-55(6) of the ITAA 1997 does not exclude the trade, because the transfer of shares alters the respective proportions in which each director will receive dividends and any distribution of capital.

When comparing the shares traded on the first day to the number of independently owned shares normally available for trading on the ASX it is considered that the number of shares traded is abnormal. Pursuant to paragraph 149-55(2)(d) of the ITAA 1997, the day of the first transfer will be a test day for the company.

The second share issue

Subsequently new shares in the taxpayer were again issued. The issue of new shares constitutes a share trade as defined under subsection 960-220 of the ITAA 1997. The issue of new shares alters the respective proportions in which each shareholder will receive dividends and any distribution of profits and thus subsection 149-55(6) of the ITAA 1997 does apply.

The evidence provided indicates that the maximum number of shares actually available for trade on the ASX at the start of the day of issue of the new shares equalled the number of independently owned shares. The controlling shareholders' shares were not available for transfer on the ASX on that day. The new issue of shares in the taxpayer increased the number of shares held by independent parties and constituted a trade equal to a substantial percentage of the pre-existing independently held shares.

Paragraph 6 of Taxation Ruling No IT 2530 Income Tax: Capital gains: Change in the underlying ownership of assets in a publicly traded unit trust: issue of new units in unit trusts and new shares in companies: interposed entities: calculation of change in majority underlying interests states that:

The issue of additional units in a unit trust or additional shares in a company is for these purposes considered not to be part of normal trading of units or shares. Where there is such an issue it will be appropriate to carry out a factual examination to determine whether there has been a continuity of majority underlying interests in the assets of the unit trust or company.

It is accepted that the 5% turnover test contained in section 960-230 of the ITAA 1997 is not satisfied.

When comparing the number of new shares issued to the number of independently owned shares previously available for trading on the ASX it is considered that the number of shares traded is abnormal.

Change in majority underlying interests

The controlling shareholders owned over 50% of the shares on issue on19 November 1985. They still owned over 50% of the shares on issue on the second test day. During the intervening years the controlling shareholders did not reduce their combined ownership interests below 50% of the issued shares of the taxpayer. Accordingly, it is accepted that there has been no change in the majority underlying interests in the goodwill of the business of the taxpayer.