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Ruling

Subject: Capital gains tax - majority underlying interests

Question 1

Has the majority underlying ownership of land acquired by you before 20 September 1985 continued for the purposes of Subdivision 149-A of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes.

Question 2

Will the land continue to be a pre-CGT asset in accordance with section 149-10 of the ITAA 1997?

Answer

Yes.

This ruling applies for the following periods:

Year ended 30 June 2012

Year ended 30 June 2013

The scheme commences on:

1 July 2011

Relevant facts and circumstances

Company

You are a private company.

You acquired land prior to 19 September 1985.

Your shareholders immediately prior to 19 September 1985 were:

§ Family member A

§ Family member B

§ Discretionary trust

Family members A and B both passed away after 20 September 1985.

Family member C is a child of family members A and B.

Upon the deaths of family members A and B, in accordance with the terms of their wills, their shares in you were transferred to family member C and the discretionary trust.

Your share ownership structure has not changed since the above occurred.

Discretionary trust

The trustee of the discretionary trust is a company. The directors of the trustee company are family member C and his spouse.

Family member C is the appointor and guardian of the discretionary trust.

The beneficiaries of the discretionary trust are detailed in the trust deed, and include:

§ Family member C and his spouse

§ The children of family member C, their brothers, sisters, spouses, widows, widowers children and grandchildren

§ Eligible trusts and companies

The discretionary trust made a family trust election with family member C being the specified individual.

Until several years ago, the discretionary trust has distributed all of the income and capital to family member C, his spouse, and you.

Subsequently, the discretionary trust distributed all of the income and capital to family member C, his spouse, and a new corporate beneficiary.

You and the corporate beneficiary have made interposed entity elections with the discretionary trust and therefore all the entities are part of the same family group.

The directors of the corporate beneficiary are family member C and his spouse.

The shareholders of the corporate beneficiary are family member C, his spouse, and a child.

There will be no change in the constitution or your shareholding or to the trust deed or composition of the beneficiaries of the discretionary trust while the land is owned by you.

You have forwarded copies of the following documents with your application:

§ Trust deed of the discretionary trust

§ Variation to the trust deed of the discretionary trust

§ Memorandum and articles of association for you.

Relevant legislative provisions

Income Tax Assessment Act 1936 Section 160ZZS

Income Tax Assessment Act 1997 Paragraph 104-10(5)(a)

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

Income Tax Assessment Act 1997 Section 149-30

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

Under section 149-30 of the ITAA 1997, an asset stops being a pre-CGT asset at the earliest time when the majority underlying interests in the asset were not held by the ultimate owners who held majority underlying interests in the asset immediately before 20 September 1985.

Majority underlying interests is defined in subsection 149-15(1) of the ITAA 1997 as more than 50% of:

(a) the beneficial interests that ultimate owners have (whether directly or indirectly) in the asset and

(b) the beneficial interests that ultimate owners have (whether directly or indirectly) in any income that may be derived from the asset.

The expression beneficial interests as used in the definition of majority underlying interests is not defined. In general law, a shareholder does not have any legal or equitable interest in the assets of a company.

Income Tax Ruling IT 2340 discusses the terms underlying interest and majority underlying interest, and former section 160ZZS of the Income Tax Assessment Act 1936. Paragraph 2 of IT 2340 advocates a look through approach in relation to chains of companies, partnerships and trusts in order to determine whether there has been a change in the effective interests of natural persons in the assets.

Where shares in a company are held by the trustee of a discretionary trust, the shares are not beneficially owned by any persons. This creates difficulties when assessing whether the majority underlying beneficial interest in an asset is maintained. In this regard, paragraph 6 of IT 2340 requires the taxpayer to show that the trustee has administered the trust for the benefit of members of a particular family at all times during the relevant years of income. Furthermore, in accordance with paragraph 8 of IT 2340, the trustee must not have exercised discretionary powers to appoint beneficiaries or amend the trust deed that would result in a practical change of 50% or more underlying interests in the trust assets.

The issue of what constitutes 'one family' for the purposes of IT 2340 was discussed at the National Tax Liaison Group (NTLG) Subcommittee on 28 November 2001. On that occasion the ATO stated that the meaning of 'family' must be considered based on the facts of the particular cases. What is often described as an 'extended' family (that is, including grandparents, children, grandchildren and their spouses) would ordinarily qualify as a 'family' for these purposes. Further, if distributions are made to post-19 September 1985 additions to a family (for example, the birth of new family members and new persons joining a family through marriage), the 'family' distribution criteria would ordinarily be satisfied.

Applying the above guidelines to your circumstances

You acquired land prior to 20 September 1985.

The change in your shareholdings occurred on the deaths of family members A and B after 20 September 1985 with the transfer of shares in accordance with their wills.

The transfer of the shares to family member C and the discretionary trust will not cause any change in the majority underlying interests in the land to happen, as family member C and the beneficiaries of the discretionary trust are taken to have held the same interests as those held by family members A and B, being the former owners (Item 2 of subsection 149-30(3) of the ITAA 1997).

It needs to be determined, however, whether majority underlying beneficial interest in the land has been maintained in relation to the discretionary trust.

The trustee's discretion was exercised to distribute all of the income and capital to family member C, his spouse, and you up until several years ago. Subsequently, the discretionary trust distributed all of the income and capital to family member C, his spouse, and a new corporate beneficiary. Family member C and his spouse are the directors of the corporate beneficiary, and are also the shareholders of the corporate beneficiary together with their child.

The terms of the trust deed and the pattern of distributions indicate that the trustee of the discretionary trust has administered the trust for the benefit of members of the family at all times during the relevant years of income. A change to the composition of the family as a result of natural death is not considered to fail the family distribution criteria as the trust continues to be administered for the remaining living members of the family.

The trustee also has not exercised discretionary powers to appoint beneficiaries or amend the trust deed that would result in a practical change of 50% or more underlying interests in the trust assets. Although a new corporate beneficiary was introduced several years ago, the look through approach indicates that the directors and shareholders of the corporate beneficiary are all members of the family.

There has therefore been no change in the majority underlying interests in the land as a result of changes in relation your shareholdings or to the discretionary trust.

Conclusion

The Commissioner is satisfied that the majority underlying interests in the land held by you have remained the same. The land will therefore retain its pre-CGT status in your hands and any capital gain or capital loss made on the disposal of the land will be disregarded under paragraph 104-10(5)(a) of the ITAA 1997.