Edited version of your private ruling

Authorisation Number: 1012591528866

Ruling

Subject: Income Tax - CGT - Application of the CGT provisions to the proposed amendments to the constitution of a company in which you hold all of the interests.

Question 1

Will the proposed amendments to the Constitution of ABC Company ("ABC Co") to convert the company into a "for profit" company, including the ability to make distributions to guarantee members, result in either CGT event A1, CGT event D1 or CGT event K8 happening for X Company ("X Co") under Part 3-1 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

No

Question 2

If question 1 is answered in the negative, will the proposed amendments to the Constitution of ABC Co to convert the company into a "for profit" company, including the ability to make distributions to guarantee members, result in CGT event H2 happening for X Co pursuant to subsection 104-155(1) of the ITAA 1997?

Answer

Yes

Question 3

If question 2 is answered in the affirmative, will the proposed amendments to the Constitution of ABC Co to convert the company into a "for profit" company, including the ability to make distributions to guarantee members, result in a capital gain arising for ABC Co pursuant to subsection 104-155(3) of the ITAA 1997?

Answer

No

This ruling applies for the following periods:

1 July 2013 to 30 June 2015

The scheme commences on:

1 July 2013

Relevant facts and circumstances

Background

X Co is an Australian resident public company.

X Co has several wholly owned subsidiaries.

X Co has not made an election to form a consolidated group for income tax purposes.

ABC Co is a public company limited by guarantee registered under the Corporations Act 2001.

X Co is the sole guarantee member of ABC Co.

For income tax purposes, ABC Co is currently treated as an "exempt entity" under relevant section of the ITAA 1997.

ABC Co is a separate taxpayer to X Co for income tax purposes.

Existing Constitution

In accordance with ABC Co's existing Constitution:

X Co has no entitlement to dividends.

X Co has no entitlement to the capital of ABC Co at the time of its winding up.

X Co has full voting rights.

X Co is currently unable to access profits or retained earnings from ABC Co due to the restrictions in the Constitution of ABC Co, and ABC Co's 'not for profit' status.

Proposed conversion from "not for profit" to "for profit" status

ABC Co proposes to convert itself from 'not for profit' to 'for profit' status. The conversion will be implemented by ABC Co amending its Constitution to allow for distributions to be made to its members (currently being X Co).

This conversion will enable ABC Co to distribute its profits and retained earnings in the future through the payment of dividends.

Once the conversion is implemented, ABC Co will cease to be treated as an "exempt entity" under the relevant section of the ITAA 1997.

Proposed amendments to the Constitution

The proposed key amendments to the Constitution of ABC Co in relation to the conversion of the company from 'not for profit' to 'for profit' status include:

-Amendments to introduce greater flexibility in the objects of the company.

-Amendments to remove the restrictions on the use of funds.

-Amendments to remove restrictions on the application of assets on the winding up ABC Co, and a provision inserted expressly allowing a distribution of assets to members.

-New clauses inserted allowing for dividend payments and associated provisions such as distribution of assets.

ABC Co will continue to be a company limited by guarantee.

Relevant legislative provisions

Income Tax Assessment Act 1997, section 50-1

Income Tax Assessment Act 1997, Part 3-1

Income Tax Assessment Act 1997, section 102-20

Income Tax Assessment Act 1997, section 104-5

Income Tax Assessment Act 1997, section 104-10

Income Tax Assessment Act 1997, subsection 104-10(1)

Income Tax Assessment Act 1997, subsection 104-10(2)

Income Tax Assessment Act 1997, subsection 104-35(1)

Income Tax Assessment Act 1997, subsection 104-155(1)

Income Tax Assessment Act 1997, subsection 104-250(1)

Income Tax Assessment Act 1997, section 108-5

Income Tax Assessment Act 1997, subsection 108-5(1)

Income Tax Assessment Act 1997, paragraph 725-145(1)(a)

Income Tax Assessment Act 1997, paragraph 725-145(1)(b)

Income Tax Assessment Act 1997, subsection 725-145(1)

Income Tax Assessment Act 1997, subsection 725-145(2)

Income Tax Assessment Act 1997, subsection 725-155(3)

Income Tax Assessment Act 1997, section 725-245

Income Tax Assessment Act 1936, subsection 160M(6)

Income Tax Assessment Act 1936, subsection 160M(7)

Income Tax Assessment Act 1936, section 160R

Reasons for decision

Issue 1

Question 1

Summary

The proposed amendments to the Constitution of ABC Co to convert the company into a for profit company, including the ability to make distributions to guarantee members, will not result in either CGT event A1, CGT event D1 or CGT event K8 happening for X Co under Part 3-1 of the Income Tax Assessment Act 1997 (ITAA 1997).

Under section 104-10 of the ITAA 1997, CGT event A1 will not happen as there will be no disposal of a CGT asset (being the guarantee membership interest held by X Co in ABC Co) as there is no change in the ownership of the interest. Furthermore, the variation in the rights attaching to the guarantee membership interest will not constitute the disposal of an asset for the purposes of section 104-10 of the ITAA 1997.

Under section 104-35 of the ITAA 1997, CGT event D1 will not happen as the amendments will not result in the creation of a contractual, legal or equitable right in another entity.

Under subsection 104-250 of the ITAA 1997, CGT event K8 will not happen as there will not be a taxing event generating a gain for a down interest under section 725-245 of the ITAA 1997.

Detailed reasoning

Part 3-1 of the ITAA 1997 contains the CGT provisions of the income tax legislation.

Under subsection 108-5(1) of the ITAA 1997, a CGT asset is any kind of property, or a legal or equitable right that is not property. The guarantee membership interest held by X Co in ABC Co, being a kind of property, is a CGT asset.

Section 102-20 of the ITAA 1997 states that you can make a capital gain or capital loss if and only if a CGT event happens. The gain or loss is made at the time of the event.

The CGT events are contained in Division 104 of the ITAA 1997.

With regard to the scheme that is the subject of this ruling, CGT events A1, D1 and K8 are considered as follows.

CGT event A1

Subsection 104-10(1) of the ITAA 1997 states:

"CGT event A1 happens if you dispose of a CGT asset."

Subsection 104-10(2) states:

"You dispose of a CGT asset if a change of ownership occurs from you to another entity, whether because of some act or event or by operation of law. However, a change of ownership does not occur if you stop being the legal owner of the asset but continue to be its beneficial owner."

As noted above, the CGT asset (as defined in section 108-5 of the ITAA 1997) is the guarantee membership interest held by X Co in ABC Co.

The proposed amendments to the Constitution of ABC Co will not lead to a change of ownership of the guarantee membership interest, as X Co will continue to own the interest and will remain the sole guarantee member of ABC Co.

However, the proposed amendments will vary the rights of X Co as a guarantee member (such as by enabling ABC Co to pay dividends to X Co). Taxation Ruling TR 94/30 Income tax: capital gains tax implications of varying rights attaching to shares expresses the view of the Commissioner in respect of the CGT consequences of varying the rights attached to shares in a company.

Paragraphs 8 - 9 of Taxation Ruling TR 94/30 state:

8. A variation in rights attaching to a share…. does not result in a full disposal of an asset for the purposes of Part IIIA [of the Income Tax Assessment Act 1936] unless there is a cancellation or redemption of the share. In determining whether a disposal has occurred under Part IIIA, it is not relevant to consider whether the variation is slight (such as a small change to the nominal value of shares) or more significant (such as disposing of the preference to receive dividends).

9. A variation in rights attaching to shares does not result in a part disposal of an asset under section 160R.

The "disposal" of an asset for the purposes of Part IIIA of the Income Tax Assessment Act 1936 (as defined in former section 160M of that Act) has been re-written to encompass CGT event A1 in section 104-10 of the ITAA 1997.

While a guarantee membership interest in a company is not a share in a company, it is sufficiently analogous that the principles in Taxation Ruling TR 94/30 should also apply to it. This is reinforced by paragraph 2 of Taxation Determination TD 2007/20 Income tax: can the attribution regime relating to controlled foreign companies apply to an Australian entity that is a member of a foreign company limited by guarantee which (on the basis of the definition of "shareholder" in subsection 6(1) of the Income Tax Assessment Act 1936 and the definition of a "company limited by guarantee" in the Corporations Act 2001) states:

2. An Australian entity that is a member of a foreign company limited by guarantee (a 'guarantee company') is a shareholder of that company for income tax purposes.

In accordance with Taxation Ruling TR 94/30, the variation of the rights attaching to a guarantee membership interest in a company does not constitute a disposal of all or part of a CGT asset for the purposes of section 104-10 of the ITAA 1997.

Accordingly, the proposed amendments to the Constitution of ABC Co will not result in CGT event A1 happening.

CGT event D1

Subsection 104-35(1) states:

"CGT event D1 happens if you create a contractual right or other legal or equitable right in another entity".

The proposed amendments to the Constitution of ABC Co will not amount to X Co creating a contractual, legal or equitable right in another entity. The proposed amendments will only vary the rights attaching to X Co's existing guarantee membership interest in ABC Co.

Paragraph 10 of Taxation Ruling TR 94/30 provides that a variation in rights does not constitute a deemed disposal of shares under subsection 160M(6) of the Income Tax Assessment Act 1936 (the predecessor to CGT event D1). As noted above, the principles in TR 94/30 in relation to varying rights attaching to shares in a company are equally applicable to varying rights attaching to a guarantee membership interest in a company.

Accordingly, the proposed amendments to the Constitution of ABC Co will not result in CGT event D1 happening.

CGT event K8

Subsection 104-250(1) states:

"CGT event K8 happens if there is a taxing event generating a gain for a down interest under section 725-245".

Section 725-245 of the ITAA 1997 contains a table of taxing events generating a gain for down interests as CGT assets. The meaning of a "down interest" is in subsection 725-155(1) of the ITAA 1997, which states:

"An equity or loan interest in the target entity is a down interest if a decrease in its market value is reasonably attributable to the one or more things referred to in paragraph 725-145(1)(b), and occurs at or after the time referred to in that paragraph…"

Subsection 725-145(1) of the ITAA 1997 states:

There is a direct value shift under a scheme involving equity or loan interests in an entity (the target entity) if:

a) There is a decrease in the market value of one or more equity or loan interests in the target entity; and

b) the decrease is reasonably attributable to one or more things done under the scheme, and occurs at or after the time when that thing, or the first of those things, is done; and

c) either or both of subsections (2) and (3) are satisfied.

Subsection 725-145(2) states:

One or more equity or loan interests in the target entity must be issued at a discount. The issue must be, or must be reasonably attributable to, the thing, or one or more of the things, referred to in paragraph (1)(b). It must also occur at or after the time referred to in that paragraph.

Subsection 725-145(3) states:

Or, there must be an increase in the market value of one or more equity or loan interests in the target entity. The increase must be reasonably attributable to the thing, or to one or more of the things, referred to in paragraph (1)(b). It must also occur at or after the time referred to in that paragraph.

We consider that there will be no decrease in the market value of the guarantee membership interest held by X Co in ABC Co as a result of the proposed amendments to the Constitution of ABC Co. Before and after the implementation of the scheme consisting of the proposed amendments, X Co will hold the sole guarantee membership interest (being an equity interest as defined in section 974-70 of the ITAA 1997) in ABC Co. No other equity interest will be issued under the scheme consisting of the proposed amendments to the Constitution of ABC Co.

With no decrease in the market value of an equity interest in ABC Co (being the guarantee membership interest held by X Co), paragraph 725-145(1)(a) of the ITAA 1997 is not satisfied.

Accordingly, there is no direct value shift as defined in section 725-145 of the ITAA 1997.

As there will be no decrease in the market value of any equity interest in ABC Co, there will be no "down interest" as defined in subsection 725-155(1) of the ITAA 1997. With no "down interest", section 725-245 of the ITAA 1997 will not be relevant, meaning that subsection 104-250(1) of the ITAA 1997 cannot be satisfied.

Accordingly, the proposed amendments to the Constitution of ABC Co will not result in CGT event K8 happening.

Question 2

Summary

The proposed amendments to the Constitution of ABC Co to convert the company into a "for profit" company, including the ability to make distributions to guarantee members, will result in CGT event H2 happening for X Co pursuant to subsection 104-155(1) of the ITAA 1997.

The proposed amendments will vary the rights attaching to the guarantee membership interest held by X Co. This will be taken to be an act, transaction or event occurring in relation to the guarantee membership interest, and will not result in an adjustment being made to the interest's cost base or reduced cost base.

Detailed reasoning

Under subsection 104-155(1) of the ITAA 1997, CGT event H2 happens if:

a) an act, transaction or event occurs in relation to a CGT asset that you own; and

b) the act, transaction or event does not result in an adjustment being made to the asset's cost base or reduced cost base.

An act, transaction or event will occur in relation to a CGT asset owned by X Co, being the proposed amendments to the Constitution of ABC Co which will vary the rights attaching to the guarantee membership interest (a CGT asset) owned by X Co. The proposed amendments will not result in an adjustment being made to the cost base or reduced cost base of the guarantee membership interest, because none of the cost base rules in Division 110 or Division 112 of the ITAA 1997 are triggered by the proposed amendments.

This conclusion is consistent with paragraphs 35 to 36 of Class Ruling CR 2004/119: Income Tax: conversion of shares and variation in rights: Golden Circle Limited, which sets out the Commissioner's view on the application of subsection 104-155(1) of the ITAA 1997 to a variation of the rights attaching to shares.

In your Private Ruling application, you have argued that paragraph 47 of Taxation Ruling TR 94/30 has the effect that CGT event H2 will only happen where money or other consideration is received or is entitled to be received as a result of the variation of rights attaching to a share or a guarantee membership interest. We consider that argument to be distinguishable from the facts of this case. Taxation Ruling TR 94/30 interpreted subsection 160M(7) of the Income Tax Assessment Act 1936, which (both before and after the amendments made by the Taxation Laws Amendment Act (No. 4) 1992) mandated the receipt or entitlement to receive money or other consideration as one of the requirements for a "disposal" (the equivalent of CGT event H2 happening). By contrast, subsection 104-155(1) of the ITAA 1997 does not contain a comparable requirement.

Accordingly, the proposed amendments to the Constitution of ABC Co to convert the company into a "for profit" company, including the ability to make distributions to guarantee members, will result in CGT event H2 happening for X Co.

Question 3

Summary

The proposed amendments to the Constitution of ABC Co to convert the company into a "for profit" company, including the ability to make distributions to guarantee members, will not result in a capital gain arising for X Co pursuant to subsection 104-155(3) of the ITAA 1997.

CGT event H2 will happen to the CGT asset, being the guarantee membership interest in ABC Co. However, there will be no capital proceeds because of CGT event H2. Thus, for the purposes of subsection 104-155(3) of the ITAA 1997, X Co will not make a capital gain from CGT event H2.

Detailed reasoning

Subsection 104-155(3) states that you make a capital gain if the capital proceeds because of the CGT event (being CGT event H2) are more than the incidental costs you incurred that relate to the event.

The table in subsection 116-20(2) of the ITAA 1997 states that the capital proceeds from CGT event H2 are "the money or other consideration you received, or are entitled to receive, because of the act, transaction or event".

Under the proposed amendments to the Constitution of ABC Co that will vary the rights attaching to the guarantee membership interest of X Co, X Co will not receive any capital proceeds (as defined in subsection 116-20(2) of the ITAA 1997).

Accordingly, X Co will not make a capital gain from CGT event H2 under subsection 104-155(3) of the ITAA 1997.